Tax-Free Savings Accounts have been touted as the most powerful investment option for Canadians since RRSPs were introduced more than 50 years ago.
On the surface, TFSAs are a simple personal savings program which allows Canadians over the age of 18 to contribute $5,500 per year into a plan and then withdraw the money, tax free.
Related: Ways To Save Inside Your TFSA
In reality, the rules about contributing and withdrawing from the plan are complex and so many of us don’t use it properly.
How TFSAs Can Make You Rich:
Personal finance expert Gordon Pape wrote the first book on TFSAs when they were introduced in 2009. Earlier this year, Pape released an updated edition called, How TFSAs Can Make You Rich.
I had the opportunity to read the latest version, which is packed with useful information and strategies on how to make the most of your Tax-Free Savings Account.
Rob Carrick, personal finance columnist at The Globe and Mail, calls it, “The definitive TFSA owner’s manual. I use it myself.”
The basics on TFSAs
In the book you’ll find the basic rules about how to open an account, what the contribution limits are, and how carry-forwards work from year-to-year.
Many of us use our TFSA as an emergency fund. Pape agrees with the need to set aside a rainy day fund, and that sheltering your interest income is a better idea than having it taxed in a regular high interest savings account.
But Pape also says you should aim for higher returns in your TFSA. While you don’t need to take needless risks with your TFSA money, you don’t need to be so conservative either, especially if you’re younger than 50. Earning an extra percentage point will add thousands of dollars to your portfolio over the years.
TFSA vs. RRSP
Tax-Free Savings Accounts offer an opportunity for even modest income earners to build up a large nest egg over time. Pape argues that, because of the low contribution limits on TFSAs, big savers are better off using RRSPs because they can shelter more money from taxes.
You should also contribute to an RRSP before a TFSA if you expect to be taxed at a lower rate after retirement. If your tax rate is likely to be higher than it is right now, as is the case for many young people, use the TFSA first.
If you belong to a pension plan, contribute to TFSAs to supplement your retirement savings, especially if you have little or no RRSP contribution room.
If you plan to buy a house, Pape suggests to save for your down payment in an RRSP rather than a TFSA and make use of the RRSP Home Buyers’ Plan.
(I disagree – First Time Home Buyer: HBP or TFSA?)
TFSAs for Seniors
If you’re not yet retired, Pape says to give careful thought to what your income is likely to be after you stop work and how much tax you’ll pay. It will help you decide whether or not to make any more RRSP contributions.
If you plan to move after you retire, check the tax rates in the province to which you are relocating.
Invest any unneeded RRIF withdrawal money in a TFSA, up to your annual limit.
Other TFSA Strategies
Splitting income – Pape says TFSAs can be used to split investment income between you and your spouse, which can potentially save thousands of tax dollars over the years. Get your spouse to open a plan as well, to double the tax saving potential.
Estate planning – Move assets from non-registered accounts into TFSAs to reduce taxes at death, beginning with securities that are likely to appreciate most in value. Name your spouse the successor holder when you open your TFSA.
Early withdrawals – Consult a financial professional before deciding whether to make early withdrawals from an RRSP and RRIF in order to make TFSA contributions.
Loan collateral – TFSAs can be used as collateral for a loan, and the interest may be tax-deductible if the money is used for investment purposes. If you are experienced and knowledgeable, you can take advantage of this to increase the size of your investment portfolio through leveraging.
That just scratches the surface on what to expect from, How TFSAs Can Make You Rich. From there, Pape describes how to invest in your TFSA and includes sample portfolios for different types of investors.
He spends 32 pages answering reader questions he’s received over the years, from basic to complex. The book then takes a look at four fictional couples and how they can end up with over a million dollars in their TFSAs.
It ends with two quizzes on how much you’ve learned about TFSAs – a beginner and an expert quiz. The expert quiz was tough!