Are you making this common TFSA mistake?
If you’re only using your Tax-Free Savings Account (TFSA) to hold cash, you could be missing out on big tax savings that come from holding investments that grow in value over time. TFSAs were created to eliminate taxes on invested money. Consider investments like mutual funds or exchange-traded funds (ETFs) to help maximize the true value of your TFSA.
Saving money isn’t easy. This is especially true for Canadians in their 20s and 30s, who may have numerous financial pressure points, including housing, student loans or children.
The Canadian government created TFSAs in 2009 to encourage people to save money. If you have already opened a TFSA, then congratulations, you’ve taken a smart step toward building long-term savings. According to a federal government report in 2017, younger Canadians (20–29 years old) opened more TFSAs than any other age group.
The most common TFSA mistake
Have you heard the saying “Cash is king?” Well, that doesn’t really apply when it comes to TFSAs. If cash makes up the majority of the money you have in your TFSA, you aren’t doing it right. But don’t worry! You’re not alone in making this mistake.
Despite its name, a TFSA is not meant to function as a traditional savings account. What you should really focus on is the “tax free” part of the TFSA name. Canadians can contribute up to $6,000 a year to their TFSA.* (You can also contribute to make up for past years when you may not have added any funds to your TFSA, but make sure you’re aware of the contribution limits for previous years.) And once that money is in the TFSA, all investment returns you earn are yours to keep, tax free. That’s right. No capital gains tax when you sell your investments, and no taxes on any dividends or interest you receive.
If you are simply holding cash, you may be earning an interest rate around 1%. That’s better than nothing, but you have the potential to earn a better return. And the bigger the return on your investment inside a TFSA, the more money you could save on taxes. For example, if you bought stocks worth $1,000 in your TFSA that rose 10% in value, that $100 gain is yours to keep, tax free. So you could miss out if you simply park cash in a TFSA.
Getting the most out of your TFSA
Instead of cash, consider an investment product like a mutual fund or an ETF. Mutual funds and ETFs offer a bundle of individual stocks or bonds in one purchase. This diversification makes them a less risky investment than buying stock in a specific company. And it makes them an attractive option for those who may be new to investing. ETFs, in addition, tend to have lower fees than mutual funds. You can learn more about the ins and outs of ETFs here.
Such investments could offer a higher rate of return than just holding cash, and therefore higher tax savings when you eventually sell them. You can make all kinds of investments in your TFSA: the aforementioned investment products, or individual stocks, bonds, or GICs.
And yes, you can simply hold cash in a TFSA, but hopefully you now see why that may not be the best idea.
Ready to start investing with your TFSA?
Consider the following funds: