TFSA Master Class – Lesson 1: Shift your tax-free savings out of ‘park’ to drive higher returns
(Reading time: 3:00)
It was author, historian, and biographer Michael King that said, “If you have a little extra parking, I err on the side of getting rid of it in favour of more greenery.”
Whether or not the writings of Michael King are a part of your own syllabus, his philosophy about parking can also translate to smart financial advice to the majority of Canadians with a Tax-Free Savings Account (TFSA).
That’s because—according to research conducted by the Bank of Montreal—65% of Canadians with a TFSA parked an average of $17,133 in cash accounts (as opposed to any type of investment), where they’re typically earning an average return of 1% or less a year.
It doesn’t take a math teacher to figure out that after inflation, that’s a negative return.
Driving your TFSA to greener returns first requires shifting how you use it.
One of the most common misconceptions is that a TFSA is a bank account. Not true. Nor is it somewhere to just ‘park’ cash. While most fully grasp the ‘tax-free’ aspect, many are unaware that a TFSA can hold almost anything including mutual funds, Guaranteed Investment Certificates (GICs), listed securities, and a wide range of qualified investment products.
A TFSA is also the perfect investment vehicle for education members because of limited RRSP room.
Whereas an educator’s RRSP contribution room tends to be limited to roughly $2,500 a year, TFSAs provide you with an added investment vehicle with the potential for serious growth when used to its full potential. In addition to providing more investment mileage, a TFSA can provide the freedom to move money with no imposed time limits for contributing and no tax penalties for withdrawing funds—giving you ultimate in and out privileges.
If you have never contributed to a TFSA: your allowable contributions accumulate from past years to increase your annual contribution limit. As of 2020, the cumulative TFSA limit is $69,500†, with the annual TFSA contribution limit being $6,000.
Note: you only accumulate TFSA contribution room when you are over the age of 18, and you must be a Canadian resident.
If you have contributed to a TFSA before (but not your maximum amounts annually): all of the accumulated contribution room will be still available for you to contribute this year, next year—or whenever you are ready.
There are also certain TFSA rules you need to know to avoid penalties when it comes to withdrawing and then re-contributing within the same calendar year, but we will elaborate more on these factors in Lesson 2.
A TFSA is also a great way to add to your pension income in retirement—and the sooner you start, the more you’ll benefit from compound interest.
Let’s say you are a 25-year-old educator who wants to put a little extra savings aside to provide you with an added financial cushion in retirement. Being in the first few years of your career most likely means starting out on the lower end of the pay grid, so saving the full TFSA contribution limit of $6,000 a year might be a little difficult.
However, if you were to even save half of the annual contribution limit a year ($3,000)—that translates to $250 a month in contributions. That’s definitely doable.
Now let’s assume you invest those contributions into an investment that consistently provides you with an annual rate of return of 3% over the next 30 years. By the time you’re 55, your TFSA will hold over $144,000.* Not bad for investing just $250 a month!
As you work your way up the pay grid, you can increase those contributions according to your budget and watch your TFSA grow even bigger.
Looking for extra money in your budget to invest in a TFSA? Here are 5 tips for saving up to $500 a month!
To sum it all up, shifting your TFSA out of park = the potential to drive greater returns.
Far from just another lot in which to park your extra cash, the Tax-Free Savings Account is a dynamic and drivable savings dynamo. So whether you’re inspired to add to your pension income in retirement, save for the summer trip you’ve always wanted to take, or simply want to have a little extra cash on the side in case of an emergency, we can help you build an investment strategy that gets the most mileage out of your TFSA.
Have questions about shifting your tax-free savings out of park? Have one of our financial specialists contact you.
†TFSA contribution room starts when you are over the age of 18, have a valid social insurance number, and are a Canadian resident or citizen.
*Calculated using a compound interest calculator and assumes a starting TFSA balance of $50.00 and that the 3% annual rate of return (compounded annually) remains constant over the duration. Consult a financial specialist for full details.