TFSA: The Misnomer Account

Most Canadians know that a TFSA is short for “Tax-Free Savings Account”.    However, from speaking to my colleagues, friends and family members, I believe that the majority of Canadians do not know how to use a TFSA properly.

Let’s first start off with the terrible name that our government chose for this investment vehicle.  In my humble opinion, the TFSA should have been named as “Tax-Sheltered Investment Account (TSIA)” or “My Own Off-Shore Tax Haven Investment Account (MOOSTHIA)“.   Although, I think the last one would be hard to remember.

Some facts that you should know about a TFSA:

  • Any Canadian over the age of 18 has accumulated contribution room since 2009.  Each year, you can add more money to your account based on the contribution limit for that year set out by our government

  • The money that you put into your account is AFTER-TAX money.   You DO NOT get a tax-deduction for contributing to your TFSA (unlike a RRSP account)

  • If you decide to take money out of your TFSA, then you have to wait until the following year to put that same amount of money back into your TFSA, assuming that you do not have any contribution room left for that year

  • You should  KEEP TRACK of your contribution room.  If you log onto your Canada Revenue Account  you can see how much contribution room you have for the year.  However, be aware that your Canada Revenue Account is not updated until the beginning of each year

  • You can open as many TFSA accounts at different financial institutions as you want, but your contribution limit remains the same.   Therefore, having 1 TFSA account is all you need.   Makes it easier to track.

  • You can invest in any investment vehicle, and the capital gains, interest and/or dividends are NOT taxed.  Exception to this rule are the 15% withholding taxes that the IRS levies on dividends from U.S stocks/ETFs, as well as withholding taxes on International stocks/ETFs.  (For more details on this topic, please see white paper by Justin Bender and Dan Bortolotti and this article by Dan Bortolotti)

Year                 Contribution Limit

2009                $5,000

2010                $5,000

2011                $5,000

2012                $5,000

2013                $5,500

2014                $5,500

2015                $10,000

2016                $5,500

2017                $5,500

2018                $5,500

Therefore, on January 1, 2018, every Canadian over the age of 18, will have accumulated $57,500 of contribution room.

What do the majority of Canadians invest their TFSA money in?   Well, “Savings” is in the name, so I can understand why the majority of Canadians mistakenly invest their money in a high-interest savings account (1-2% interest).

DO NOT USE your TFSA as a “Savings Account”!

Our government has given us a powerful investment tool.  Use the TFSA to its full potential investment power!

It would be kind of like buying a high-end luxury car with “x”-hundred horsepower and using the car only to drive to the neighbourhood grocery store every day.  Of course, I would never buy a costly luxury car…..

Use your TFSA to invest in ETFs or real estate!

I am sure that you have heard of the power of compounding with your RRSP.  Just like your RRSP, your TFSA is tax-sheltered and allows for compounding to do its job without any interference from taxes.  However, unlike a RRSP,  you will NEVER have to pay any more taxes on this money.   When you are ready to use the money from your TFSA, you do not need to pay any taxes, unlike a RRSP.

QUIZ TIME:

Ms. Saver is 35 years old.  She has never opened a TFSA account.   She decides to open a self-directed TFSA account on January 1, 2018.   She has been a diligent saver, like the Millionaire Teacher, and has saved up $57,500.   She decides to contribute the full amount into her TFSA

She chooses to invest in real estate (I will discuss how to invest in real estate in a later post), earning 10% annualized return, and contributes $5,500 each year for the next 10 years.   (Let’s assume that the government keeps the contribution limit to $5,500 each year for the next 10 years).

After 10 years, her TFSA account has compounded to $236,796

Ms. Saver is now 45 years old and withdraws the entire $236,796 on December 1, 2028.    She was going to use the funds for a downpayment on a new house, but then suddenly changes her mind.   She decides to wait a couple of more years before buying and will instead stay in her current house.

Ms. Saver knows that she has to wait until the following year (next month) to re-contribute into her TFSA to avoid penalties, as she had already contributed in 2028.

Recall: TFSA contribution was $57,500 in 2018.  10 additional years of $5,500=$55,500.  Ms. Saver contributed a total of $112,500 into her TFSA.

QUESTION #1:  

Ms. Saver’s TFSA’s gain for the 10 year period was $124, 296 ($236,796 – $112,500).

When Ms. Saver withdraws the entire $236,796, how much tax does she have to pay?

A) $0

B) 25% Capital Gains ($31,074)

C) 50% Interest Income ($62,148)

ANSWER: A

Ok, that was an easy question.  If you read the post, then you should have answered this question correctly.

Now a harder question…..

QUESTION #2: 

On January 1, 2029, how much can she contribute to her TFSA?

A) $112,500

B) $57,500

C) $55,500

D) $236,796

E) $242,296

F) None of the above

ANSWER: E

Not only does the TFSA contribution limit grow with each year’s limit increase that the government offers, but it also grows with your investment growth.

Ms. Saver took out $ 236,796, so her TFSA contribution room would now be $236,796  as of December 1, 2028.   On January 1, 2029, she can add the annual $5,500 limit increase as well, so $236,796 + $5,500 = $242,296

Don’t feel bad if you answered this question incorrectly.  I have asked my colleagues, friends and family members this question.  None of them got the correct answer.

Hope you learned something about TFSAs from reading this post.

What do you invest in your TFSA?  Did you know that you can invest in real estate with your TFSAs?

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Thrilled to see this article. The misbranding of this tool is a real shame and I like your names better. The biggest shame is that is probably the best tool for someone with a lower income yet was reduced by the current government with the argument that only rich people can use it. Someone in a lower tax bracket doesn’t get as much benefit from an RRSP since they don’t get much of a tax refund. If that person built their TFSA instead, they could have a huge tax free retirement income stream that doesn’t even result in OAS clawbacks!