The tax-free savings account (TFSA) is a freaking unicorn of an account that the Canadian government introduced in 2009. Similar to the Roth IRA for Americans, this account allows you to contribute up to $5,500 per year and any interest you earn inside this account will not be taxed. I am such a fangirl for the TFSA that I can actually save you from reading the rest of this post: if you do not have a TFSA, you need to go open one NOW. I think the vast majority of Canadians can benefit from having one. So let’s dig into this a little bit more:
What is a TFSA?
Welcome to the most poorly named account ever created. TFSA is a total misnomer and it should be treated as more of an investment account than a savings account. Because the big win with a TFSA is that you do not pay taxes on the money when you withdraw it like you would with an RRSP.
Tell me more, you say? Gladly.
Here are key takeaways about the TFSA:
They can also do all the things with your money!
I think the biggest mistake people make with the TFSA is that they deposit money into it as if it is a regular savings account. Just like an RRSP, you can invest your money in a TFSA into all kinds of fun things like index funds and GICs. Please please please invest the money in your TFSA, and you will see why this is important in my next point –>
They are tax-sheltered!
What does that mean? All that beautiful money that accumulates inside of your TFSA…it’s ALL yours. Unlike the RRSP, the TFSA is not tax-deferred but it is tax-sheltered. Meaning? You have to pay tax on your money on the way in but not on the way out.
In essence, the government has agreed that if you make a buttload of cash on the investments in your TFSA, they will not tax you on those gains. If that money was sitting in a regular account, you better believe they are taxing a minimum of 10% on those earnings.
Do you want to earn a lot of interest over many years and then not give the government any of it? I know I do.
What does this look like? You invest $10,000 in a TFSA and leave it alone for ten years. Assuming a 7% annual return, you have $19,671 in that account at the end of ten years. You do not have to pay taxes on that $9,671 of earnings. Freakin A.
You can take the money out whenever you need it!
Holy sh*t, this may not sound like a big deal but the fact that you can withdraw money from this account whenever you want is a HUGE deal. Unlike an RRSP where you face serious penalties for withdrawing before the age of 65 (except in a couple specific circumstances), you can pull the money from your TFSA to pay cash for a car. Put a down payment on your house. Go to Burning Man. Whatevs.
I am not saying you SHOULD do that, but it is nice to have an account alternative to the RRSP that is way more flexible and can be used for a variety of short and long-term savings goals.
In fact, I treat one of my TFSAs (I have two) as my emergency fund. Money in your TFSA can be withdrawn anytime and you can actually get your hands on it within 24-48 hours, making it kind of great for an emergency fund. My emergency fund earns 1.95% interest and is nice and accessible if/when I really need it.
The only catch: if you have hit your total contribution limit (i.e. $52,000) and you withdraw money from your TFSA, you cannot re-contribute that dollar amount until the next calendar year.
You can contribute up to $5,500 a year!
Since its inception in 2009, the government has given $5,500 of contribution room to the TFSA each year (with the exception of 2015, where they jacked it up to $10,000). If you have never contributed a dime, the contribution room rolls over.
That means for anybody who was 18 or older in 2009 and has been a resident of Canada that whole time – you have a whopping $52,000 of contribution room in your TFSA!
If you have been a non-resident of Canada during that time, I highly suggest you check your contribution online at cra-arc.gc.ca. For instance, my contribution room is $35,500 (which lol, as if I’m running right up against that limit). If you want to know more, check out my recent post about how else your finances will be impacted when you move abroad.
This is great and everything…but which accounts should I have?
Totally with you. I opened a TFSA in 2009 because my mom told me to.
And remember how I only opened an RRSP through work six months ago because someone handed me a bunch of paperwork to fill out and then I magically had an RRSP? I had no idea if I actually needed one or not. So how do you know where to send your dollars each month?
Some key things to help you decide:
Are you an average to high-income earner?
The cut-off is somewhat arbitrary but if you make more than $40,000 a year, it makes a lot of sense to put money toward an RRSP. Especially if you are a high-income earner (think 200K+), the tax savings are too good to pass up. You will get back almost half of the money you would normally be paying in taxes (i.e. if you contributed up to the limit of $24,930, you save about $12,000 in taxes).
Will you have a lower income in retirement than you do now?
For most of us, that’s a big PROBABLY. If you are one of the few remaining humans in Canada that still has a defined benefit pension plan, then you need to think about if that income paired with your investments would actually lead to you having more cashflow in retirement than you do now. If that is the case, a TFSA can be a great option.
Do you plan on retiring early?
This account is absolute gold if you are working toward financial independence at a young age. If you have max out your TFSA today, that account will have matured to over $100,000 in the next ten years – assuming you do not contribute another dollar in that time. Unlike your RRSP (and 401(K) for Americans), which you have to sit around and wait to access, you can tap your TFSA anytime in early retirement.
I hope that cleared up some of the nonsense around RRSPs and TFSAs. I know, it is still a bit of a mindf*ck trying to figure out where you should be saving your money. The bottom line is that it is better to get started with something than to do nothing at all for your future.
I think just about everybody can use a TFSA. If you have a lower income and an RRSP doesn’t make sense, then you definitely should have one! If you max out your RRSP, you probably have some extra cash that you can invest and the TFSA is a perfect vehicle for that. For most of us, this account is a winner and I highly encourage you to check out Wealthsimple if you are looking at getting started with a TFSA online.
So tell me: how are you doing with your investment and retirement planning? How do you decide how much money to allocate to your designated retirement account (RRSP/401(K)) and how much money to invest through other avenues like the TFSA, Roth, or HSA? Let me know in the comments!