When the federal government launched the Tax-Free Savings Account in 2009 the news was mostly met with confusion. In a brief MoneySense article announcing the birth of the TFSA that year, even we admitted that “most of us are still trying to figure out how to make the best use of them.” Indeed, our article went on to quote experts who said you shouldn’t hold stocks in your TFSA, and that you shouldn’t use it for short-term savings. That advice now seems wrong-headed, but it’s unfair to pick on the experts: it was too soon to see the TFSA’s potential. But no longer.
The TFSA is so much more valuable today than it was six-plus years ago. Back when it was a baby, you could contribute just $5,000 annually. While that was a nice perk, it wasn’t going to change anyone’s financial situation: even if you maxed out your TFSA that year, earned 4% interest and were in a 30% tax bracket, your tax savings amounted to all of $5 a month. But now the TFSA has grown into a strapping young adult with shoulders broad enough to support your retirement—and maybe all of your other investment goals as well.
For starters, you’ve got much more room to play with. In 2013, the Harper government increased the TFSA annual contribution limit to $5,500, and then ramped it up to $10,000 this year. That means any adult over 24 has now accumulated $41,000 of TFSA contribution room. Couples can enjoy $82,000 of tax-free bliss, with another $20,000 accumulating every year. Suddenly that nice perk has become a tool for building real wealth.
Unfortunately, the TFSA’s benefits are still poorly understood by many Canadians. Because it has “Savings Account” in its name, some people still think it’s just a place to stash cash: in fact, you can use it to hold stocks, bonds, mutual funds, ETFs and many other investments. Others dismiss the newer, bigger TFSA as a benefit only for rich Canadians, when it’s actually much more valuable than RRSPs to low-income families. And every year tens of thousands of taxpayers are slapped with penalties for over-contributing to their TFSAs, simply because they’re confused by the rules. (For the record, if you withdraw from your TFSA you don’t get the contribution room back until the following year.)
While many investors fail to take full advantage of the TFSA, many others are using them when they probably shouldn’t. If you’re a high-income earner, the RRSP can still offer more potential tax savings—even though you’ll need to report all of the withdrawals as income when you retire. And if you’re putting money into a TFSA while carrying consumer debt you’re probably paying a lot in interest just so you can save a little in tax.
The TFSA isn’t the right investment vehicle for everyone, but it’s no longer the RRSP’s poor cousin: it’s now becoming the go-to account for Canadians young and old. In the pages that follow, we’ll help you harness the power of the grown-up TFSA.