For higher-risk investors it’s tough to beat the benefits of a TFSA
Eric Tippelt | February 24, 2017 | SmallCapPower: In 2009, Canadians were given a very valuable gift. It is called the TAX FREE SAVINGS ACCOUNT, or TFSA. Unfortunately, or maybe by design, the value of this gift was not well explained. Too many people think this is just another Savings Account. Barely 50% of Canadians actually have one. The TFSA should be your most important account, even more important than the RRSP.
The TFSA is similar to the RRSP as far as both are a file folder that you can put investments into. They both can hold the same type of investments, and you can have more than one TFSA account in more than one place just like an RRSP. Like the RRSP if you do not contribute the limit, it carries over to the next year. There the similarities between the TFSA and RRSP end.
The current limit on TFSA contributions is only $5,500.00 a year, as opposed to the RRSP, which is 18% of income. Any money you take out of your TFSA can be added to the limit in the next tax year. For example, you have put in the limit for 2016 by May. You withdraw $2,500.00 from your account in August. You cannot replace that $2,500.00 until 2017. In 2017, your total limit is $8,000.00.
TFSA contributions are NOT TAX DEDUCTIBLE. It might seem strange that there is that low a limit on the TFSA, but not when you see what the TFSA can do for you.
Unlike the RRSP the TFSA is TAX FREE. Taking money out of your TFSA can be done, by you, online. Sometimes it takes a day or so, depending on the institution, but there is NO WITHOLDING FOR TAXES and YOU DO NOT HAVE TO CLAIM THE MONEY AS INCOME!! There are also no restrictions on what you can use the money for. It is your money.
Let us look at an example. You put $500 into your TFSA online trading account. You buy a stock that goes to $5000.00. You sell the stock in the TFSA. You buy more stocks in the TFSA that go up to $25,000.00. You decide to buy an income property and want to use your TFSA money as the down payment. You go online and transfer the full $25,000.00 to your chequing account. There are no Tax issues, and you do not have to claim the money as income.
You will not be able to claim the $500.00 you put into the TFSA originally as a tax deduction, so there is no possible refund triggered by this contribution. Let us look at another example.
You are putting money away for your retirement. You can put it in a TFSA, or an RRSP, or both. You split the contribution between both. You do this for 20 years, and buy the same investments in each account. They both reach a value of $500,000.00 at retirement. You take out $10,000.00 from each account. Out of the TFSA you get $10,000.00 TAX FREE, and you do not have to include it as income on your Taxes. Out of the RRSP you get only $7000.00 because they withhold 30% to cover taxes, and you will have to claim the $10,000.00 RRSP withdrawal as the type of income it is, on your Tax return.
For younger people, the best thing about the TFSA is that any withdrawal is not used in calculation of government assistance, which has a means test, (based on income) whereas the RRSP is. For people closer to retirement, TFSA withdrawals are TAX FREE. Now you know why there is a low limit on the TFSA contributions.
I max out my TFSA each year before contributing to my RRSP. You may want to rethink this if your company contributes to your RRSP based on what you contribute. If they do a $1.00 for $1.00 contribution, remember, that is a 100% return on investment, and, increases your tax deduction. This is not something to overlook. Paying tax on money you got for free is not a bad deal. There is no program for allowing your company to contribute to a TFSA that I know of.
I started making RRSP contributions over 30 years ago. I have only had my TFSA since 2009. By placing my highest return investments into my TFSA, I have grown it to half the value of my RRSP. Best of all I WILL PAY NO TAXES WHEN I TAKE THE MONEY OUT FOR MY CONDO IN VEGAS!
Eric Tippelt is a full time professor of electrical automation at Loyalist College in Belleville. He has been studying money and finance since 2004 when he began his online trading activities. Eric writes about Micro Investing ($500.00 to $1,000), because there is very little information out there on how to invest at that level.