Since they were introduced in 2008, Tax Free Savings Accounts (TFSAs) have become a popular money saving tool for Canadians. Many people have come to see them as a great way to save up money, tax free, to use for a rainy day or a major purchase down the road. What most Canadians don’t realise, however, is that TFSAs can be used for much more than just tax free savings. With the right investment portfolio, a TFSA can be not only a great way to keep the taxman off your back, but also a significant tool for growing your wealth in the long term.
RBC found that 65% of their clients who used TFSAs either had their money invested in GICs, or used the TFSA as a high interest savings account.
Look Beyond GICs
A few years ago, RBC took a look at how their clients saved money. They found that 65% of their clients who used TFSAs either had their money invested in Guaranteed Investment Certificates (GICs), or used the TFSA as a high interest savings account. While this approach does provide a certain sense of constancy and security, it doesn’t do a lot in terms of growing your wealth. On average these types of accounts will yield a return rate of 1 to 2%. Even with the current $10,000 annual contribution limit, a rate of 2% would only earn you $200 per year on a $10,000 investment.
If you’re simply using your TFSA as a way to safely store money without being taxed, then this might be the best approach, but if you want to get more out of your TFSA, there are other approaches to consider.
Focus on Investments First
While using a TFSA as a tax shelter can be beneficial, focusing on the tax shelter aspect of a TFSA rather than the investment aspect is like putting the cart before the horse. Yes, the tax shelter is important, but it only really becomes beneficial when your investments start to yield high returns.
One good strategy for growing your wealth with a TFSA is to include dividend paying stocks as part of your account. While this option involves a little more risk than, say, a GIC, the return can also be much greater. Once you have investments that are paying out at a rate of 5 to 10%, then you really have a good reason to tax shelter your earnings.
Consider Your Debts
Something else to consider before opening a TFSA is whether your investment could be better used to pay down debt. If you have a car loan at an interest rate of 5 or 6%, you may be better off putting your savings towards paying down that loan rather than worrying about keeping those savings tax free. You can always take the amount you save by paying off your debts earlier and use that to start a TFSA at a later date.
One thing most people don’t realize about TFSAs is that they can be used as an extra form of life insurance for people who are married.
Use Your TFSA as an Estate Settlement Advantage
One thing most people don’t realize about TFSAs is that they can be used as an estate settle advantage for people who are married. When most married people open a TFSA, they will name their spouse as the Beneficiary, meaning that their spouse will be paid out the full amount contained within the TFSA if they pass away. This can be helpful, but a better option is to name your spouse as Successor Owner on the account; that way your spouse can keep the account open after you pass away and keep your TFSA investments tax free for as long as they want.
Find the Right Investment Portfolio for Your Needs
The best way to use a TFSA to grow your wealth will differ for every individual and every family, so the best thing you can do is to talk to one of our financial advisors to determine which approach is right for you. Ultimately, your investments have to fit within your risk tolerance, your time horizons, and your goals. Once we’ve established those factors, we can help you determine whether or not a TFSA is right for you, and if so, which approach will be best.