Tips on how to get the most out of your TFSA

The Tax-Free Savings Account (TFSA) is a fantastic tool for Canadians to save and invest money.

It’s an extremely popular account, and there are over 15.3 million total TFSA holders in Canada as of 2019, according to the Canada Revenue Agency (CRA).

Here are eight tips on getting the most out of your TFSA:

1. INVEST INSIDE YOUR TFSA

Because the TFSA contains the words “savings accounts,” many Canadians think that all you can do is save in one, when in reality, it is much more versatile. Your TFSA can also hold various investments, including stocks, bonds, ETFs, mutual funds, and more.

You can invest in your TFSA in multiple ways:

1. All major banks will have TFSA accounts that you can open and hold investments in by simply calling them or visiting a bank branch, but this might be an expensive option with high fees as they will usually try to get you to invest in mutual funds.
2. A cheaper way is to look at investing in a TFSA using robo-advisors. You’ll have your portfolio selected for you based on your risk tolerance and goals.
3. If you really want to save on fees, the best way is to open a TFSA and directly invest yourself using a discount broker, but that requires the most investment knowledge.

Investing is where the true power of the TFSA is unlocked because if you invest tax-free over a long time period, you can potentially earn much better returns than if you were to just simply save money in an account. It is important to choose investments that match your risk tolerance and investment goals.

Keep in mind that investing in a TFSA carries risk, and there is the chance your investments could lose money, especially in the short term.

If you insist on still using your TFSA for savings only, keep in mind that certain banks have much higher rates than others, so shop around to find the best rates.

2. CONTRIBUTE REGULARLY

You can contribute up to $6,500 per year (as of 2023) to your TFSA.

If you haven't used your TFSA contribution room from previous years, you can still make contributions to catch up.

If you've never contributed to a TFSA before, you can contribute up to $88,000 if you're eligible for the entire amount in 2023.

Make regular contributions to take advantage of the full contribution limit and to grow your investments or savings over time.

3. USE YOUR TFSA FOR LONG-TERM GOALS

A TFSA is a great vehicle for achieving long-term financial goals because all the investment income and capital gains earned inside your account are tax-free.

Consider using your TFSA to save for important long-term goals such as retirement.

4. DON'T WITHDRAW FUNDS UNNECESSARILY

Avoid withdrawing funds from your TFSA unless it's absolutely necessary.

Every time you withdraw funds, you lose the contribution room for that year, which means you might not be able to contribute that amount again until the following year without a penalty.

You also lose out on the real magic of the TFSA, which is if you hold investments inside of it for long enough, the tax-free compounding effects can potentially earn you large returns over time.

Note that the penalty is only relevant if you are close to your total TFSA contribution limit. If you aren’t near that limit, this probably won’t affect you.

Here are a couple of examples of how this works:

1. Suppose you have a TFSA limit of $88,000, and you have already contributed the maximum of that amount. If you withdraw $10,000 from your TFSA, then you won’t be able to re-contribute it until the following January without penalty.
2. Suppose you have a TFSA limit of $88,000, but you’ve only used up $50,000 of that limit. If you withdraw $10,000 from your TFSA, then you can still contribute up to $38,000 ($88,000 minus $50,000) that year without a penalty.

5. AVOID OVERCONTRIBUTING

Overcontributing to your TFSA can result in penalties from the CRA. The current penalty for overcontributing to a TFSA is 1% per month of the excess amount until it is withdrawn.

For example, if you overcontribute $1,000 to your TFSA, you will be charged a penalty of $10 per month until the excess amount is withdrawn.

If you accidentally overcontribute, you should withdraw the excess amount as soon as possible to minimize the penalty charges.

It is important to keep track of your TFSA contributions and withdrawals to avoid overcontributing. You can check your contribution limit by logging into your CRA account or contacting the CRA directly.

6. CONSIDER USING YOUR TFSA TO HOLD HIGH-GROWTH ASSETS

If you want to invest in high-growth assets, such as small-cap stocks or emerging market funds, consider holding them in your TFSA.

That way, any capital gains earned won't be taxed, allowing you to maximize your returns.

Be careful with this strategy, as high-growth assets can potentially lose a lot of money as well.

7. GIVE MONEY TO YOUR SPOUSE TO INVEST IN A TFSA

There are no joint TFSAs in Canada. If you have reached your TFSA contribution limit but your spouse or common-law partner hasn’t, consider giving them money to contribute to their TFSA.

This can help maximize your tax-free savings as a couple.

8. AVOID USING YOUR TFSA FOR DAY TRADING

If you use your TFSA for day trading, the CRA may consider it to be a business, and you may be subject to taxes on your trading profits.

This can be especially problematic as day trading can lead to large gains or losses in a short amount of time, and the taxes owed on those profits can be substantial.

MAIN TFSA TAKEAWAYS

Remember, the key to getting the most out of your TFSA is to make regular contributions, invest and save wisely, and use it for long-term savings goals.

Also, avoid withdrawing the TFSA for as long as you can. The earlier you start contributing, the more you can take advantage of the compounding effects of the TFSA.

Christopher Liew is a CFA Charterholder and former financial advisor. He writes personal finance tips for thousands of daily Canadian readers on his Wealth Awesome website.

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