Go back and re-read the title until it’s burned into your brain.
A Tax Free Savings Account – TFSA – is a wealth creation tool. So long as your money is under the tax-repelling protection of the TFSA, then the government will not tax your money. The second thing to remember is that the government also will not any money that’s withdrawn from the TFSA.
When the government decides not to tax your money, then you’d better sit up and pay attention.
The TFSA is not just for savings!!! It’s enraging that the Canadian government gave one of the best investment vehicles of all time a name that causes so much confusion. The name leads people to think that savings is the primary use of this magnificent wealth-creation tool.
Believing that the TFSA can only be used as a savings account is wrong.
Why do people think the TFSA is a savings account?
The word “savings” is part of the name of the account. Including this word in the name has caused a great many people to assume that this account is simply a savings account. The government did a disservice to the populace by not calling this a Tax Free Investing Account.
From this moment forward, when you think of a TFSA, I want you to only think about which money-making investment you’re going to stuff into it. Do you want something that churns out dividends every single month, a la an army of little money soldiers? Or would you prefer to buy growth stocks that results in juicy capital gains when you sell them? Perhaps you’re just looking to invest in index funds, mutual funds, exchange trade funds (ETF), or a real estate investment trust (REIT)?
The Tax Free Savings Account is not just a savings account. Any investment that can go into your registered retirement savings plan (RRSP) can also go into your TFSA. Once your investment is inside the TFSA, any and all investment returns will grow tax free.
The other tasty cherry on this particular sundae is that all withdrawals from your TFSA are tax-free as well. Did you happen to invest $5000 into stock of the Next-Big-Thing within your TFSA and that $5000 is now worth $750,000? Well, my friend, I’m happy to tell you that you can withdraw that $750,000 from your TFSA completely tax-free.
Yes – that’s how good a Tax Free Savings Account really is.
Higher tax-free returns are a good thing.
Investments in equities are more volatile, but they have a long-term historical average return that is much higher than anything you’ll get at the bank. Let’s say you decide to buy an index fund that invests in the stock market and you’re going to hold it for 10+ years. Based on historical averages, that investment should return around 8% if held. In other words, so long as you don’t panic during the ups-and-downs of the market and you don’t sell, your investment should return around 8% at the end of those 10+ years.
Find yourself a nice little compound interest calculator. Enter 8% return, a 10-year time period, and the amount of capital that you plan to invest. Write down that number. Now go back to the calculator. Enter the 0.5% return your savings account will pay you, a 10-year time period, and the amount of money that you plan to keep in a savings account. Write down this second number.
I think you’ll find that earning a higher return over the same period of time means that more money will stay in your pocket. Remember that your money will grow without being taxed if you put your investments inside your TFSA.
Consider Using a TFSA for Long-Term Investing
Hopefully I’ve convinced you to look at the TFSA in a new light. If so, yay for me. If not, then so sad for you. The TFSA is a gift – check out this articulate, ascerbic article from Garth Turner of Greater Fool if you don’t believe me.
And it’s a shame that people aren’t taking advantage of it.
To those who’ve been persuaded that the TFSA can help them build wealth, I say the following:
- Create a balanced portfolio of investments.***
- Put this balanced portfolio inside your TFSA.
- Leave the portfolio alone to grow tax-free inside your TFSA.
***What’s that, you say? You don’t know how to create a balanced portfolio of investments? Well, don’t fret. There are ways to learn how to do it. I suggest that you start by reading Garth Turner’s blog – Greater Fool – and learn for yourself. (I am not being paid for mentioning his website.) Remember – you don’t need to pick the perfect portfolio. You need to create a portfolio that you understand: some equities, some bonds, some cash. Those are the three magic ingredients that will bolster your chances of creating some serious wealth for your future needs.
Don’t let analysis-paralysis prevent you from starting to use the TFSA as it was should be used, as a vehicle for you to invest your hard-earned money and to watch it grow tax-free. The TFSA isn’t just for savings!
Do not use your precious TFSA room as a way to shelter money that is earning a very low rate of interest. Bank accounts are for holding short-term money. Long-term money needs to be put into investments. Wherever possible, your long-term investments should be protected from the ravages of taxation.