Tax is one of the main reasons preventing you from being financially independent.  If you’ve taken a look at your paycheque, you know that taxes takes a huge cut from your pay and it can even take up to 52% of your annual income! However, the Tax Free Saving Account (TFSA) is one of the few and best tax saving vehicles in Canada. In this article, I will finally give you a solution to avoid paying taxes legally, through the TFSA and how to best use it to achieve your financial goals.

Employment Income:

Employment income was explained in depth in my previous article “Who do you ACTUALLY work for?”

Recap example: Your full-time job as a nurse you make an annual salary of $50,000 you have to pay taxes of about 30%. So at the end of the day, you are left with only $35,000 (50,000*70%). This is unfortunate, and sadly a TFSA can’t help you here.

Investment Income:

In last week’s article, “How to Invest to Make Money” I explained when we invest in stocks/shares, we get taxed on our investment income which includes capital gains and dividends.

This is where the TFSA can help you pay less tax.

Recap example: Let’s say you buy 100 Apple shares. Apple pays out a $1 dividend. So you receive $100 each year. This is considered investment income and it is taxed at an approximate rate of 29%. Therefore, in normal circumstances you will pay $29 (100*29%) of taxes.

However, a TFSA acts as a tax shelter for your investments. So any investment income from dividends or capital gains in the TFSA are TAX FREE.

Analogy:

Think of the TFSA as a pot that holds all your plants. The plants represent all your investments (stocks/shares). If your plants are in the pot, it protects them from the FIRE aka taxes. :’D

 

Comparison

Let’s look at a scenario that compares investments in a TFSA and not in a TFSA.

Example: You buy 10 Apple shares for $10. Each year Apple gives out a 5% dividend and you reinvest it to buy more shares. Looking at the chart and graph below, you can see a BIG difference in investing using a TFSA and not using a TFSA.

In 10 years, the difference is only $218 which is not much of a difference. However, in 30 years, the difference is $1,515 which is quite significant. The reason for this is the compounding effect, which is when returns or interest on money build on top of one another, resulting in exponential growth.

The tax free returns coupled with the compounding effect makes the TFSA one of the best saving vehicles in Canada.

Benefits:

1. With the tax savings, you can reinvest it to buy even more stocks/shares to obtain a greater dividend/capital gain in future years.
2. Flexibility: Can easily take out your money from a TFSA if you need it without any tax consequence. So if you want to buy a house in 5 years, you can empty out your TFSA.

**However, there is a limit to how much you can put into your TFSA. Use this calculator to figure out how much you are eligible to put into your TFSA.**

Summary

  1. Open up a TFSA account at your bank and put your money in it!
  2. Set up monthly contributions that go from your bank directly into your TFSA
  3. Since you can take out money whenever you please, use it to save for your Short/Medium Term goals (3+ years) (ex. A downpayment for a car or house)
  4. Reap the rewards of Tax Free Returns

Share this article with a friend who might benefit from a bit of $$ advice. 

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