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5 Benefits of a TFSA

 Mike Nesselback

Learn how to use a Tax-Free Savings Account to grow you wealth tax free.

A TFSA or Tax-Free Savings Account, has many benefits for all Canadians to grow their wealth and save for their financial goals such as a trip to Mexico or a new car. Are you 19 years or older? You can open a TFSA forfree with any banking institution, and some banks allow you to open the account online in less than ten minutes. To talk about the great benefits of a tax-free savings account, we first must understand how to contribute to them.

1. You can continue to be a procrastinator, and still benefit later.

The Canadian Revenue Agency sets a limit every year for how much an individual can contribute. In 2016, you can contribute a maximum of $5,500 per year. If you did not fully contribute in the past in any given year, there is room for you to make additional contributions. For example, if your opened a TFSA one year ago and did not contribute when it was first opened, you would be eligible to contribute $10,000 this year.

2. Profits made within the TFSA do NOT get taxed.

Although you still pay taxes on the money you contributed to your TFSA, any money made from dividend investments, interest, or capital gains does not get taxed. To illustrate, Jill currently has $10,000 in her TFSA. She used her TFSA contributions to invest in a water utility company. Over the course of the year, the water utility company’s stock price rose and Jill’s investment gave her a $1,000 profit. Instead of giving some of this profit away to the government in capital gains taxes, Jill gets to keep all the money she profited. Other investments allowed in a TFSA include: Guaranteed Investment Certificates (GIC’s), bonds, and mutual funds.

3. Withdraw your money with ease.

If you use a TFSA to save for a trip, or for other big expenditures, you don’t need to worry about the inability to access your funds. With this account you have the ability to withdraw money whenever you like, making this account great for both short and long term savings goals. Any withdrawals you do make are not taxed as well. In the previous example, this would make Jill very happy because she can use her whole $1,000 profit from investments for any purchase she likes.

4. Uses of a Tax-Free Savings Account.

Saving for large expenditures. The TFSA can be used for multiple purposes due to the account being versatile in contribution and withdrawal amounts. A very common purpose of a TFSA is to save for large expenditures when you are working. Instead of using a savings account and receiving around 0.60% interest on your money, within a TFSA account you can buy a GIC (Guaranteed Investment Certificate) that currently guarantees you a return of about 1% if invested for more than two years. This is a 40% increase you can be making on your money, allowing you to save for your trip or house a lot sooner than you would by strictly putting your money in a savings account.

Emergency Fund. The ability to withdraw any amount of funds in a TFSA makes it great for starting an emergency fund. If you were in the unfortunate situation of being laid off from the significant drop in oil prices, an emergency fund would be essential to survive. Emergency funds are a great way to save yourself when unexpected events happen in life… and trust me, they happen a lot. Fall down the stairs and miss a week of work? Don’t worry about the loss of pay from taking time off, because your emergency fund can help you get through this tough time.

Saving for retirement. If you are like me and in your 20’s, you are likely not thinking about your retirement, although it is a smart time to think about this. A tax-free savings account is a great way to get started saving for retirement. With other registered savings account such as RRSP’s (Registered Retirement Savings Plan), the TFSA contributions compliment these accounts by increasing available wealth at time of retirement.

5. No income requirements.

A major advantage of a TFSA related to other registered accounts is that you do not need to have income to contribute. Other registered accounts like the RRSP mentioned above have an income requirement that only allows you to contribute if you are earning an income. This makes a tax-free savings account eaily accessible for students in university or retired seniors. This is extremely valuable if a person with no income comes across a lump-sum of money, and can put that money into a TFSA.

The great benefits of a TFSA versus a regular taxable investment account, contributing $5,500 annually, and earning a 2.5% rate on a 10 year GIC can be seen below. In the regular taxable account, we used tax equal to 14.10%, which is the tax bracket for the average Canadian salary ($49,000) on capital gains.