Tricks of the Trade of Using Your TFSA
We all love hearing the words tax free! So I'm always excited when the new year rolls around because that means I get to put more money in my TFSA.
The TFSA or Tax-Free Savings Accounts is an investment vehicle for Canadians - similar to the Roth Account in the US. Within the TFSA, any capital gains, interest earned and dividends are never taxed allowing you to grow your money even faster. This is opposed to a non-registered account (regular account) in which dividends are taxed, interest is taxed (any interest earned is added to your income and taxed accordingly) and 50% of all capital gains are taxed.
How do contributions to the TFSA work?
The TFSA was launched in 2009 and each individual above 18 years old was allowed to put 5,000$ in the account. This was raised to 5,500$, 10,000$ and then reduced back to 5,500$. The limit for 2017 is 5500$.
Remember that contributions only start when you turn 18.
The element to remember with TFSA’s is that you are able to withdraw money from the account at anytime, however if you have reached the max contribution you must wait till the following calendar year to re-deposit what you withdrew.
If you over-contribute at anytime – you will be taxed – so be sure to know your contribution limits.
Although the annual limit is 5500$ - you can contribute any amount that you want. Any unused room is carried-forward so you never lose your contribution room.
For more info on contributions rooms visit http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/tfsa-celi/cntrbtn-eng.html
The renowned debate - TFSA or RRSP?
One of the biggest ongoing financial debates in Canada is the TFSA/RRSP debate.
Both of them are registered accounts – with the TFSA offering tax sheltered growth for life and with the RRSP offering tax deductible contributions.
The best way to take advantage of your RRSP is contributing when your deductible is capable of knocking you down a tax bracket – to generate more tax savings. It is also better if you are a higher income earner so that your deductible gives you more dollars back. Remember that an income of 12,000$ has no tax anyway so for low-income earners it's to better to contribute to your TFSA. If you still want to contribute to your RRSP – make the contribution now but save the deductible for the future to experience greater tax relief.
The basis of RRSP is simple contribute now to get a higher tax deductible and withdraw it later in retirement when your income tax rate is presumed to be lower. Now this may not always be the case so its important to strategize.
What is your personal advice for holdings in the TFSA?
Personally, one of the best things I like about the TFSA, is the tax sheltered growth. For this reason, I like holding some growth and dividend producing holdings to take advantage of this aspect.
Now some people just hold cash in their TFSA and at todays interest rates assuming 1% in the account = 55$ a year. While 55$ untaxed is still good – what kind of taxes would you pay on that anyway?
However, if you were to purchase a dividend stock that yields 4% this would generate 220$ in dividend income which is a lot more substantial. In addition, growth stocks have shown to provide higher returns in the past allowing me to grow my money faster while avoiding capital gains taxes.
Again it depends on your risk tolerance as well.
Is the TFSA good for day-day saving?
TFSA is not the account for you if you plan on making withdrawals on daily, weekly or monthly withdrawals. The reason being if you make constant moves in the account you can get taxed if you over-contribute and making constant moves can make it hard to track your savings. Since investing is also a long-term activity its recommended to let your investments grow un-touched this way you can also experience all upward swings in the market and get the complete compounding effect. For day-day savings, a savings/chequing account is better.
Disclaimer: All of the above information is my own personal opinion. It should not be taken as financial advice. Please consult with CRA and your bank for exact contribution limits. Please do your research and consult with a licensed financial representative before making any financial decision.