Using a Tax Free Savings Account can be one of the best choices for you financially. The TFSA allows you to earn tax-free investment income on the money you put into the account. Ultimately, the TFSA is a long term investment tool that can help you save and earn money.
Despite the fact that more Canadians are using TFSA’s rather than RRSP’s than ever before, studies show that they aren’t using them to their full advantage.
Most Canadians are using their TFSA to store their savings rather than growing and protecting their wealth.
Where should I open a TFSA?
The best places to open the TFSA give you the highest return on your money with the lowest fees. For that, we recommend Wealthsimple if you want someone else to do the legwork for portfolio management for you or Questrade, if you feel confident investing yourself!
It’s important to assess your TFSA usage to ensure you are getting as much out of it as you can. You might be screwing it up without even realizing it. Here’s how:
1) Not using it to save for retirement
Of the surveyed Canadians, only 38% use their TFSA to save for retirement. The best way to save for retirement may vary depending on your income and career. There are valid comparisons of RRSPs and TFSA’s, but the flexibility of the latter is what makes it a great option for anyone.
What the TFSA lacks in tax benefits, it makes up for in its lack of tax consequences. If you have a generally lower income, you should definitely be using this account to save for retirement.
One of this account’s most idyllic benefits is that it allows you to access your money at any time before retirement without consequences. It also provides you with extra room to invest if you happen to have maxed out your RRSP contributions for the year.
In addition to this, any withdrawals made from your TFSA can be contributed again in the following calendar year. This is not the same case for an RRSP in which any withdrawals made can’t be re-contributed, losing you contribution room.
2) Not Investing in the stock market
News flash: your tax-free savings account is NOT a storage unit for cash. Despite the fact that this account gives you a chance to grow and protect your investments on a tax free basis, hardly any Canadians are using theirs beyond storing spare money!
First thing’s first, what is the stock market?
MAG has provided you with a guide to the stock market for dummies that will get you started on making the most of your stock market investments: What is the Stock Market?
Individual stocks and bonds are a good way to develop a wider portfolio asset location. Fund your TFSA with regular contributions and shelter your investments which would otherwise be taxed at the highest rate.
3) Using their TFSA as an Emergency Fund
I think we all know by now that an appealing part of this savings account is that you can take money out when you want, for any reason, without being taxed.
But this doesn’t mean you should be constantly withdrawing. In fact, that truly defeats the purpose of the account.
You should be saving for emergencies in a High-Interest Savings Account. To better prep you for emergencies, a HISA is a great place to keep risk-free cash and build your fund for any imminent situation.
4) Not maxing out in the account
The TFSA is unique in that it has an annual limit of what you can put in it. And this aspect is determined by your age and personal finances.
Too many Canadians are making the mistake of not maxing out the account. And truly this is what you should try to do in order to reap the full benefits of it.
When you max out your TFSA, it has the potential to become a $1 million asset. In fact, for those in your 20’s and 30’s, the only way it won’t become a $1 million asset is if you don’t use it. So start saving!
5) Making withdrawals from their TFSA to pay off debt
Much like many things in personal finance, this is dependent on the type of debt you may have. That’s why it’s called personal finance, after all.
But if you want your TFSA to grow you should simply not be taking money out of it.
At Money After Graduation, we believe that debt repayment is a marathon, not a sprint. A.K.A leave your TFSA out of it, and work on other strategies for debt repayment.
One of my favourite ways to go about this is the Debt Snowflake Method. Low-stress, personalized strategies are ideal for paying off your debt. They won’t interfere with the growth of your TFSA and will likely increase the speed at which you pay things off!
6) Not knowing their contribution limit
As I previously mentioned, the TFSA has an annual and lifetime contribution limit. It is important to know this limit so you can save accordingly and successfully. If you don’t know your limit, here’s a guide to calculate it: How to Calculate Your TFSA Contribution Limit.
Not knowing this limit can easily result in losing money. The Government of Canada is tracking your TFSA usage and will charge you a penalty fee of 1% per month of the over-contributed amount until you withdraw it.
The last thing you want is to burden this useful tax structure with unnecessary fees so keep a diligent eye on your contributions.
If you haven’t yet, you should start using a TFSA now
Likely the way most people are screwing up their TFSA is simply by not using one. Clearly this type of account has tons of benefits, so long as you use it, and use it right!
*Interest is calculated daily on the total closing balance and paid monthly. Rates are per annum and subject to change without notice.