The Key To TFSAs, And Why You Need One
Two weeks ago we gave you a rundown on 'What is an RRSP and Why You Need One.' Now let's talk about another type of investment account, the Tax-Free Savings Account - better know as, the TFSA. 💰
What is a TFSA, really?
TFSA stands for Tax-Free Savings Account (...😴).
You can grow the money you have in your TFSA tax-free and keep more money in your pocket by putting your investments inside a TFSA account (💸💸💸).
You can think of a TFSA as a place to hold your investments. The most common investments are:
Cash
Bonds (also known as fixed-income)
Equity (investments in companies that participate in the stock market)
The difference between a regular investment account and a TFSA investment account is how you are taxed on the money that is invested.
Can you withdraw from a TFSA?
You can take money out of your TFSA anytime, without any penalty.
Example: Let's say you take out $1357 this year to buy a new computer. You will pay no tax on this withdrawal, and it won't be added to your income for the year. You will then have $1357 of additional contribution room that you can put back into your TFSA.
Caution: You can not put the money back into your TFSA in the current tax year. If you take $1357 out in 2021, you need to wait until 2022 to put it back in, unless you still have room to contribute to your TFSA this year (eg: you only contributed $2000 to your TFSA in 2021 and still have $4000 of contribution room to use).
What happens next is that next year you will have $1357 of additional contribution room that you can put back into your TFSA. So if the contribution limit is $6000 again next year, you’ll have $6000 + $1357 = $7,357 that you can put into your TFSA (plus any room that you didn’t use up in previous years).
Can I have more than one TFSA?
While we prefer having our investments in one place so it’s easier to keep track of, there are lots of reasons why you might have TFSA accounts at different financial institutions.
You can have as many TFSAs as you’d like. The only thing that you have to make sure of is that you don’t put more in per year than you’re allowed to contribute.
Some institutions (big banks, we’re looking at you), will charge you to transfer your money to a different institution. If you’re thinking of moving your account from one company to another, then get the new company involved. They will sometimes absorb the fees for you or reduce them slightly, and they will make sure that everything is transferred properly. Double check what the fees/implications are before you transfer.
Why should I invest?
Let’s say you’re 30 years old, and make $55,000 a year. If you want to be able to maintain 70% of your lifestyle, you’ll need roughly $1,000,000 saved by the time you get to retirement.
In order to save that, you would need to put away about $2,400 a month. ($2,400 a month times 12 months in a year is $28,800. If you save $28,800 every year for 35 years, you’ll have $1,008,000).
Let’s take it even further, after-tax (in Alberta) you would have $42,300. To hit this savings target you would only have $42,300 - $28,800 = $13,500 to live off of. That’s $1,125/month.
Now let’s look at what happens if you invest in a portfolio that makes 4.5% after fees year over year.
If you put $810 in an investment every month, and it has a return on investment of 4.5% (let’s say there is a MER: Management Expense Ratio of 1.5% - then the fund would need to make 6% in order for you to get a 4.5% return - this is why minimizing fees are so important) then after 35 years you’ll have $1,000,000.
So let’s recap - if you save your money you would need to save $2,400 a month.
If you invest your money, you would need $810 a month.
You will reach your goal, and you will have needed $1,590 less (or roughly a third) than saving the money alone.
Also, the later you start, the more you have to invest, we’ll get into that more in the next section.
When should I invest?
Start today - get those wheels in motion! A lot of work has been done to democratize investments and make them more accessible to people. There are great robo advisors that have good portfolios that you can invest in and start getting the benefits of investing.
We mention the example below a lot, but it’s because it’s so important. TIME is your biggest advantage when it comes to investing.
The earlier you contribute to your retirement, the more likely you're going to meet your retirement goals. Especially if you are a woman. Most women will earn less money during their lifetimes, but if you start investing early, you can make your money work for you.
We'll illustrate this with an example, in a perfect world where your money earns 6.1% each and every year:
Investing $100 at 25, leads to $1000 at 65. BUT, investing that same $100 at 45, leads to only $300 at 65. That is roughly a third of the money than if you had started earlier.
*In real life, your returns will fluctuate every year.
Why do I need a TFSA?
We've already talked about the power of investing to help you reach your goals.
When you invest in a regular investment account (called a non-registered account), you will be taxed on:
DIVIDENDS: Some companies pay out earnings in the form of dividends - this often happens quarterly (you will pay lower taxes on dividends than on income).
DISTRIBUTION: Some ETFs and Mutual Funds have distributions - this is money that they have made from holding stocks within the basket, in an ordinary account, you will be taxed on this money, and you’ll also have to keep records of your Adjusted Cost Base. Make sure you check with a tax professional.
CAPITAL GAINS: When you sell an investment (stock, ETF, fund) for more than you bought it for, that difference is called a Capital Gain, and you need to pay tax on half of the money you make.*
*If you lose money it is called a Capital Loss, and it can be used to reduce your taxes - but it doesn’t make up for the money lost, just takes a bit of the sting out of it.
When is the last day I can contribute to my TFSA?
The last day you can contribute to your TFSA for the year is December 31st, but the deadline isn't as pressing because the contribution room carries forward to the next year.
Let's look at an example:
Let’s say you have $6000 you want to contribute in 2020 (and the contribution room to go along with it) , and December 31st comes and goes and you forget to make your contribution. You can just as easily contribute $6000 on January 1st, 2021 and it will be fine.
What is my TFSA contribution limit?
You get more contribution room on the 1st of January every year. Just to keep things spicy 🌶, the government varies how much you’re allowed to contribute. See the following table to the right.
What happens if I overcontribute to my TFSA?
Caution: There are steep penalties for over-contributing. You will be taxed at 1% of the excess TFSA amount each month the account has an over-contribution.
How do I find how much contribution room I have?
You can call the Tax Information Phone Services (TIPS) at 1 (800) 267-6999. You can also go to My Account or MyCRA.
Caution: Financial institutions have until February to report the TFSA numbers to the Canada Revenue Agency (CRA), so your contribution room for last year may not be up to date until March of the current year.
Your TFSA contribution room information can be found by using one of the following services:
Represent a Client (if you have an authorized representative)
Note: Any contributions that are made or withdrawn from a TFSA in the prior year may not be reflected in your available current year contribution room until after the end of February. All issuers have until the last day of February to electronically submit a TFSA record to the CRA for each individual who has a TFSA. Any transactions made in the current year will not be included.
Who can open a TFSA?
Any Canadian resident who is over the age of 18 can open a TFSA. You will need your SIN number to open the account.
Where can I open a TFSA?
Most financial institutions offer TFSA accounts. Make sure that you open one that can hold investments, and not one that is a cash account.
At Untangle Money we have a strong preference for low fees, and the lowest fees are found at Robo Advisors. Questrade has Questwealth which offers the lowest fees we’ve seen so far for a balance between $1000 to $99,999 at 0.25%. They are also very transparent about additional fees (which are MERs - Management Expense Ratio - or the management fee to make the fund that you put inside your account)
I've opened a TFSA, now what can I do?
Sometimes you’ll need to transfer money into the account, other times you'll have to do this in order to open the account.
Either way now you need to put that cash into some sort of investments.
If you go with a Robo Advisor, or a company that offers pre-built portfolios, you just need to select the portfolio that fits your needs the best.
A rule of thumb is to roughly invest your age as a percentage in bonds, and (100 - your age) in equities (or stocks).
What should I invest my TFSA in?
There are lots of options for you! One reason we like robo-advisors at Untangle Money, is that most of them have preselected diversified portfolios that can help you if you’re feeling stuck, and get you started with investing.
There are literally thousands of financial products to choose from. With robo-advisors, you don’t pay much for the ability to have different types of financial products in your portfolio (which is good for risk and returns), and these portfolios have actually been shown to do better over the long run than most human advisors and over 90% of all mutual funds (because the fees are lower in both cases) .
You can hold many different types of assets, including:
Cash (we don’t recommend leaving cash uninvested for long - get that money working for you),
GICs (Guaranteed Investment Certificates),
ETFs,
Mutual Funds (we would hesitate before investing in mutual funds at Untangle Money, they tend to have high fees and could be paying your advisor more than you are earning),
Individual stocks (we also don’t recommend - unless you’ve educated yourself on the firm and can afford to lose that money),
Options (tread very carefully and make sure you understand the risks of trading options, this is one place where you can lose more money than you put into the trade in the first place).
Caution: You don’t want to hold US shares or other foreign shares in your TFSA. Let’s walk through this for US shares:
Say: Coca-Cola. The tax treaty Canada has with the United States doesn’t recognise the TFSA as a retirement account. As such, any gains you make on the Coca-Cola shares - including dividends - will automatically have 15% non-resident withholding tax taken off from your account. Because you don’t live in the US, the US tax authority taxes you on your gains. Depending on the tax treaties, it may be similar with other countries foreign shares.
Caution: You can’t hold OTC (Over-The-Counter) stocks in your TFSA. OTC stocks are also called non-listed. This is because they aren’t traded on major exchanges (they aren’t listed there). Another word for them is penny stocks. Usually OTC/non-listed/penny stocks come with addition risks. The movie Boiler Room is about pumping and dumping penny stocks. This can actually happen in real life, and people are getting concerned that places like Wall Street Bets on Reddit, are the new world version of boiler rooms.
Choosing between a TFSA and an RRSP.
Still unsure which investment account is the right one for you right now? Checkout our Investment Accounts breakdown (click each image to make it bigger)!
What's next?
Figure out how much money YOU need to retire, and make a plan to get there. You can purchase our MINI for a better understanding of your retirement picture, and to see how TFSAs can make a difference for your future!
At Untangle Money we help women understand their (real!) financial picture, and obtain financial guidance from people that actually, really, get it. We would love to help you, too. Join the community of hundreds of other women looking to strengthen their financial well-being. You can get in touch here for a free consultation.