The question that keeps us busy is “How do I achieve my financial goal”.
The first step is to put a financial plan in place and working on ways to achieve the goal. Some of these include, saving before spending, allocating 10-20% of income towards building retirement corpus, paying credit card bills in full etc. Today, I will focus one of the strategies that our clients use effectively to create a savings fund which they can use in event of an emergency. This strategy is:
Tax Free Savings account (TFSA)
A TFSA is a registered investment or savings account that was introduced by the federal government in 2008. It is a flexible investment account with contribution limits that allow an individual to earn tax-free investment income and capital gains in the account.
Canadian residents aged 18 years or older with a social insurance number (SIN) can open a TFSA. Contributions to a TFSA are not tax deductible, withdrawals are tax free and you regain your contribution room the following year. You do not need earned income to accumulate contribution room. There is no requirement for TFSA to covert to any other plan at any age.
The annual TFSA contribution limit for 2020 is $6,000. Any unused contribution room is carried forward indefinitely. That means Canadians who were at least 18 years of age in 2009 (when the TFSA first came into effect) now have a cumulative maximum of $69,500 in TFSA contribution room.
The advantages of TFSA:
TFSA give Canadian residents financial and tax planning options outside of taxable investment accounts and Registered Retirement Savings Plan (RRSP).
TFSA withdrawals are not taxed and not included in taxable income, meaning there is no impact on the income-tested benefits from the federal government such as Old Age Security (OAS) and Guaranteed Income Supplement (GIS).
For example, amount of $10,000 invested in funds in a non-registered account and subsequently sold at $12,000 by the end of the year, would require one to pay tax on the investment’s growth (called a capital gain) by declaring 50% of the earnings (or $1,000) as income on the tax return. If instead the same investment is made within a TFSA, one would not pay any tax on the capital gain. So all investments are tax sheltered within a TFSA.
For those who aren’t investing yet, a TFSA can be the perfect place to start. If you have one in a bank in a high-interest savings account, while it might be a smart option only if you expect to make frequent withdrawals from your TFSA, it is not a good strategy for long-term savings. Bank interest does not typically keep up with the rate of inflation, meaning that the purchasing power of your long-term savings will erode over time. It is recommended to invest regularly (for e.g.: monthly amount) to capture growth in specific instruments.