The Tax-Free Savings Account (TFSA) is one of the best vehicles to build long-lasting wealth available to Canadians. This is because you can earn a completely tax-free income on your investments. Any interest, dividends, or capital gains within your TFSA will never be taxed. This is unlike other investment vehicles like the Registered Retirement Savings Plan (RRSP), where you don’t pay taxes on the years you contribute but will pay taxes when you make a withdrawal. So, this article will focus on how to build wealth using your TFSA.
As you will find out, TFSA is one of the fastest ways to build wealth. You protect your capital from taxes while it grows and this allows your money to compound. So, if you don’t yet have a TFSA, you need to open one today. If you have TFSA already, you need to look for ways to make the most of it henceforth. Below, you will find some things you can do to make the best of your TFSA and build wealth.
1. Understand Your TFSA Contribution Limit
As you probably know, the TFSA has both annual and lifetime contributions limits. TFSA was introduced in 2009. So, if you were at least 18 in 2009, your total contribution limit, as at today, will be $69,500. If you were born later than 1991, your total lifetime contribution room depends on your age.
One of the most reliable ways to check your available contribution room is to check your online account with the Canadian Revenue Agency. The CRA tracks all of your TFSA contributions and update it at the beginning of every calendar year. You can also check your latest tax return for your TFSA contribution room.
If you don’t know how to find out what your contribution room is, see below a step by step instructions:
- Go to the CRA My Account login
- Log in with your preferred method.
- Under the tabbed header, navigate to RRSP and TFSA
- Click Tax-Free Savings Account (TFSA)
- Click Contribution Room
- Click Next at the disclaimer
- Look for TFSA contribution room. This value is your most accurate contribution room since the date.
Knowing your contribution room allows you to save accordingly. If you find out that you have not yet maxed out your TFSA, work towards making extra contribution this year to catch up.
2. Open more than one TFSA
While there is no limit to the number of TFSAs you can open, your contribution limit remains the same. For example, if you have $52,000 in contribution room available and have two TFSA accounts you could still only contribute a maximum of $52,000 to either of the accounts, not both. Likewise, your lifetime contribution room remains the same according to your age. So, always ensure you add up the sum in all your TFSAs to make sure you are still within your limits.
If TFSA is the vehicle you are using to save, you should try to have both cash and investments under the TFSA umbrella. For example, you can open a mutual fund or brokerage account for your long-term retirement savings.
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3. Dedicate one income stream to grow your TFSA
To max out the annual contribution room for your TFSA, you will need to save at least $458.33 per month. With the effect of Covid-19 and high costs of living, most people find it difficult to save at least $458 every month. In order to achieve this, you may need to start a side hustle and use the income to fund your TFSA. This allows you to free up the cash from your regular pay-cheque for other financial obligations. Another thing you can do every year is to put your income tax refund in your Tax-Free Savings Account.
If you can not max out your TFSA this year, do not beat yourself up. You can always catch up in the future when you income increases. The most important thing you need to know is that earning tax-free returns on any amount is better than $0. So, saving $1,000 or even $500 is still a good step in the right direction. Stop making excuses and get started today.
4. Develop the habit of making monthly contribution
No matter what your financial goal is, you need to be disciplined. Otherwise, you will only continue to live in a fantasy land. So, make a commitment to save something in your TFSA every month no matter how small it is. Decide today to simply stash away a regular sum of money every month. I know the actions required to do this can be hard.
The best trick is to implement automatic monthly contributions. Most TFSAs allow you to do this. For example, you can have $100 automatically withdrawn from your bank account each month, with the proceeds deposited into your TFSA. So, take advantage of this feature. If you want to save consistently, trust an algorithm. Open your TFSA right now and establish automatic contributions even if the monthly sum begins small.
5. Use your TFSA to build wealth
Most people use their TFSA to save for vacations or consumables. This is a waste of resources. Your TFSA should be used for what it is i.e. a place to earn tax-free investment income. Don’t use your TFSA to “save” money that you plan to spend. Consider the money in your TFSA off-limits. In other words, every penny you put into this account should be untouchable. One way to keep your hands out of your TFSA is to keep it at a different institution than your primary bank. When you log on to your online banking, you won’t see your savings and that removes the temptation to make a withdrawal.
6. Use your TFSA for investment
While most people already know this, many don’t take advantage of this. So, use your TFSA to invest. Your TFSA should not only be a savings account. You can use it buy investments like GICs, stocks, bonds, ETFs, mutual funds, and more. By buying higher-return investments like mutual funds or stocks, your investment will grow faster and you will really reap the rewards of tax-free gains. There are different brokerages that allow you to do this. So, choose the one that works for you.
7. Let compound interest work for you
Compound interest is the most powerful force in the universe. It is the addition of interest to the principal sum of a loan or deposit, or in other words, interest on interest. Compound interest is the result of reinvesting interest, rather than paying it out. The interest you earn next will be earned on the principal sum plus previously accumulated interest.
The TFSA annual contribution maximum is currently set at $6,000. So, if you invest everything annually for five years and you earn a 10% rate of return, you will end up with $40,000. This is not a bad return on investment. If you continue this for a decade, your contributions would grow to $105,000. This is despite the fact that your contribution within the same period will just be $60,000. Your return will be four times higher even though the savings period was only double the length. So, let this sink. Compound interest means that the longer your money stays in a TFSA, the faster it grows.
Finally, make a commitment to start this journey today. Even if you have huge debt, you can still find a way to set aside something every month in your TFSA. So, start today.
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