Your Tax Free Savings Account (TFSA) is one of the best tools to save on taxes. But a TFSA should not be called a savings account, and instead it should be called an investment account.
In this article, I’ll be sharing why you should use your TFSA as an investment account and not as a savings account.
What is the Tax Free Savings Account (TFSA):
The TFSA is an account that can hold investments or cash. The reason why a The TFSA is an effective tool because any income generated in your TFSA is TAX FREE. But, there is a limit to how much money you can keep in your TFSA. It is based on the year you turned 18, and you can calculate it using this link. Because of this limit, we want to make the BEST use of your TFSA benefit.
Let’s take a look at the benefit if we were to use the TFSA as an investment account.
An investment account is a place to buy, hold, and sell investments. Investments can be stocks/bonds/etfs/mutual funds/etc.
So let’s say you have $10,000 of investments in your TFSA, and in 10 years it’s valued at $30,000. You just generated an income of $20,000. This income is called a capital gain, because you sold your investments higher than when you first bought it.
Capital gains are a unique type of income, where only 50% of the gain is taxed. So the total Taxable Capital gain is $10,000 ($20,000 * 50%) = $10,000
For simplicity sake, let’s assume a 30% tax rate. So if your investments were NOT in a TFSA you would have to pay $3,000 ($10,000*30%).
In other words, the tax saving benefits of using a TFSA as an investment account is $3,000. This $3,000 is a significant amount of money. Wouldn’t you just love it if someone gave you $3000?
This is the benefit of having your money in a TFSA, but let’s take a look on why you should not hold your TFSA through a savings account.
A savings account is a place to hold your money where you easily access your cash and you get a small interest return. The average interest on a savings account can range from 0.05% – 2%.
For this example, let’s assume a 1% interest rate. If you have $10,000 in your savings account, in 10 years you’ll generate about $100 per year. That’s about $1000 ($100*10) over 10 years.
Assuming a 30% tax rate, you’ll pay a total amount of tax of $300 ($1000 * 30%).
As you can see, saving only $300 over 10 years is quite insignificant. You probably blow $300 at one or two stops at the grocery store.
By keeping your savings account in a TFSA, not only are the benefits insignificant, but you are also wasting your limited TFSA contribution room for investments.
Overall, the tax saving benefits of the TFSA is extremely useful, but there is a limit to how much you can keep in your TFSA. For that reason, you want to hold Investments in your TFSA that give you the highest tax benefits.
Holding your savings in a TFSA not only has limited tax savings benefits, but it also takes up your limited TFSA contribution room.
So someone should really change the name of the Tax Free SAVINGS Account, to the Tax Free INVESTMENT Account… It would make things a lot less confusing.