Summary of Video
Introduction to TFSAs
Topic: Overview and Proper Usage of TFSAs
Hi everyone, today we are going to talk about TFSAs. If you have a TFSA, it is important to ensure that you are utilizing it correctly. Today’s conversation will highlight a common mistake many individuals make with their TFSAs. Our goal is to provide insights that could help rectify this mistake or reaffirm that you are on the right track with your current approach.
Understanding TFSAs
Topic: Basics of Tax-Free Savings Accounts (TFSAs)
Before discussing the common mistake, laying a foundation of what a TFSA entails is essential. A Tax-Free Savings Account (TFSA) is designed to shelter your savings or investments from taxes. This means earnings from interest, dividends, and capital gains within a TFSA are not taxed. It’s a versatile account that can hold various investment vehicles, such as stocks, ETFs, and mutual funds, offering a tax-free advantage for Canadians.
Savings vs. Investing with TFSAs
Topic: Distinguishing Savings and Investing in the Context of TFSAs
The term “Tax-Free Savings Account” can be misleading, as TFSAs are not just for savings but are also effective for investing. Saving refers to keeping money in a safe place with minimal interest, typically for short-term goals or emergencies. On the other hand, investing involves purchasing assets with the potential for significant growth over time, albeit with some risk. Recognizing the difference between these two approaches is vital for optimizing your TFSA.
Common Misstep: Misallocating TFSA Funds
Topic: The Opportunity Cost of Improper TFSA Contributions
A prevalent issue with TFSAs is the misallocation of contributions, failing to consider the opportunity cost given the account’s contribution limits. As of 2024, the cumulative limit is $95,000, with an annual cap of $7,000. Prioritizing savings over investments within a TFSA can hinder your ability to leverage it for higher-yielding opportunities, leading to inefficient use of this tax-advantaged space.
Leveraging TFSAs for Retirement
Topic: Utilizing TFSAs for Optimal Retirement Benefits
In retirement planning, using TFSAs predominantly for investments rather than savings offers more significant benefits. Investments grow tax-free within TFSAs, and withdrawals, such as OAS, do not impact income-tested government benefits, avoiding potential clawbacks. This strategic use supports a more tax-efficient retirement income, emphasizing the importance of viewing TFSAs as a tool for long-term investment growth.
Conclusion and Further Guidance
Topic: Summary and Resources for Enhanced Financial Planning
In conclusion, while TFSAs provide flexibility for both saving and investing, avoiding the common oversight of not fully utilizing their investment potential is critical. Always consider the strategic placement of your funds within a TFSA to ensure you maximize growth and tax efficiency.
FULL TRANSCRIPT
Introduction to TFSAs
Hi everyone, today we’re going to talk about TFSAs. If you have a TFSA, you want to make sure that you’re doing the right thing. Part of the conversation we’ll have today is about mistakes, specifically one common mistake I see individuals making with their TFSA. Hopefully, you’ll learn something from this, and if you’re making that mistake, you can make changes. And if you’re doing great, well, this is confirmation that you should continue doing what you’re doing. So, let’s talk about it.
Understanding TFSAs
Before we discuss the mistake I see a lot of people make with their TFSA, I’m going to lay some groundwork, some foundation, about what a TFSA is, just so we’re on the same page. So, what is a TFSA? As the name suggests, it’s a Tax-Free Savings Account. And essentially, it lets you save or invest money without paying taxes, right? So, by the way, the conversation will be around saving and investing. We’re going to talk about that. But let’s lay a bit more foundation before we get there. You typically don’t pay taxes on a TFSA for the money that you put in it, right? So, the extra money you make from your investments, that goes tax-free. The extra money you put in, if you’re using it for savings, that interest also goes tax-free. Now, you can invest your money in different ways within your TFSA, you can use stocks, ETFs, mutual funds, seg funds, etc., a range of different things. But the big takeaway is any money you put in, the interest or the capital gain, or the dividend that you may earn from that is completely tax-free, which is one of the last opportunities we have here in Canada. So it’s a great vehicle for investing. So let’s talk more.
Now, we talked about having a TFSA and using it for savings or investing. And quite frankly, the name Tax-Free Savings Account is part of the challenge here because most, hold on, I’ll say most, but a lot of people will look at the TFSA as a place for savings.
Savings vs. Investing with TFSAs
So let’s talk about savings and investing and differentiate them. So, first thing is saving. Savings is putting money in a secure place, and you earn a small amount of interest over time. And the whole point of a savings account is usually something safe, secure, easily accessible. And this is usually for an emergency fund. You have three months of expenses. You want to have that saved up, three to six months. For certain individuals, you may want to go a year. And you know,
The thing here is you do not want that to be subject to market volatility because you may need that money in the short term. So, not only emergency funds, but you may be saving for a car, you may be saving for a stove or a refrigerator, or maybe, you know, for something larger, maybe a home, you may be pretty close to getting your home and you’re using the FHSA, the Home Buyers’ Plan, you know, and the TFSA is also part of that equation.
So, that’s what savings is, essentially putting your money in a secure place, for money that you may need to access in the short term, right? Now let’s talk about investment. When you talk about investing, you’re putting money to buy assets. And the benefit here, the potential here, is that you want a higher growth in value, right? You’re putting money in with the hopes that you could get a much more decent rate of return than you essentially get for savings. And when you think of savings, you go to the bank, or whatever the interest rates have been offered. That’s going to have an effect on how much rate of return you could get from having it in that savings account. Now, investing is usually more long-term, and you’re looking for higher growth. You want higher growth and opportunity for increasing value, which typically comes with some degree of risk, right?
And so, the reason why you’re thinking more long term is if you need the money in the short term and it’s in something that’s subject to market volatility, when you go to take the money, it could be a day or two before, you know, you might have some fluctuations and negatively affect how much you have in that account. You may have just lost money. So, you’re going in, and you’re in a worse situation than you were in when you put money in, right? So, you put money in, and you’ve lost. So, that’s where in situations like that,
We’re thinking savings may make sense, but short-term investing isn’t the best place typically for long-term growth. But then again, it comes with risk. So, you may say, “Good, I could use a TFSA for savings or investing.”
Common Misstep: Misallocating TFSA Funds
So, where is the mistake? The mistake is there’s an opportunity cost aspect of the TFSA, which means it’s not unlimited. We hope it is. For many of us, we hope someday we get a bit more room. Well, for now, the cumulative amount is $95,000, right? And the annual contribution as we speak, in 2024, it’s $7,000, right? So there’s only a certain amount of money that can go into the TFSA. So, if you have, you know, a couple of hundred thousand dollars and you’re thinking about where to invest, if you have your savings in a TFSA, that means it takes away the opportunity to invest in a TFSA.
Now, if you’re saving in the TFSA, and we talk about savings again, the we should talk about interest rate, which is usually lower. And I say usually because, you know, in recent times we’ve had some okay, decent returns, but in the long term, in most situations, what you’re going to find is there’s an opportunity to make a higher return investing. And if you have a bunch of money, a lot of your money in the TFSA, where you are just using it for savings and getting a minimal rate of return, it means potentially you have money that is being invested outside of that TFSA that will be subject to taxes, right? So there’s an opportunity cost there. And for many people, especially if you’re looking towards retirement, using that TFSA for investing is super important and in the long run will make more financial sense. And definitely from a tax standpoint, it makes a lot of sense because, as we said, there’s tax-free growth. Now this tax-free growth could be savings where you’re earning a minimal amount of interest, or it could be tax-free growth where you’re making a decent amount from an investment growth from your investments, right? So, that’s one of the reasons why you want to potentially look to the TFSA as a place to invest versus save.
Leveraging TFSAs for Retirement
The other thing is when you pull money from a TFSA in your retirement, it doesn’t affect government benefits. A lot of government benefits are based on your income, and especially something like OAS, this is Old Age Security. When you’re pulling money from that, once you reach a particular threshold, you’re going to have what’s called potential clawbacks, right? So if you’re making, say, $90,000 in retirement, this is over the threshold, then there’s a potential clawback here. Now, if you were taking, say, $30,000 from your TFSA, that would have brought you below that threshold.
And so you wouldn’t have that clawback, but you’d have received the same amount of money. So, it protects you from potential clawbacks or anything having to do with government benefits. And quite frankly, what it really does is it maximizes the opportunity for you to have a huge or a decent amount of retirement income. Because when you pull that money out, you’re pulling it out tax-free, unlike RRSPs, unlike CPPs, or other pensions that you may receive. So what you’re doing is creating a structure
from a tax-efficient standpoint. You have a portfolio that is more tax-efficient. So, you have a certain amount of money, but if it’s not tax-efficient, when you go to pull it out, you’re going to be hit with taxes. So that’s why I think TFSAs should be used mostly for investment for a lot of people, at least the clients that I see. It’s more beneficial as an investment versus being used for savings. There’s an opportunity cost here, right? So, if you have, you know, hundreds of thousands of dollars because you’re saving towards retirement, you definitely want to look to the TFSA. Definitely want to look to maximize your TFSA from an investment standpoint. Hopefully, this was helpful. Hopefully, you could take something away from this. And because you see “Tax-Free Savings Account,” don’t think that a TFSA is only for savings. Or even if you know that you can use it for investment, really consider the opportunity cost here.
We could be putting money into the TFSA and having tax-free growth in the long term versus having to pay taxes when you pull it from an RRSP or even taxes from a non-registered account.
Conclusion and Further Guidance
Now, if you want to get a sense of what your financial picture is, because I’m just talking about TFSAs here, here’s an opportunity. I have teamed up with a company where you could use this QR code to go there and get a sense of your financial snapshot. Take a look at that. It may be helpful. And also, I have an Amazon bestseller called “The Art of Retirement”. I’ve gotten pretty decent feedback on it, and I know the author, so maybe you think I’m just saying that, you know, but I really have gotten pretty decent feedback on it. They say it’s an easy read and people found it helpful. It’s about retirement planning, including estate planning,
So definitely want to check that out. I’ll drop links to both these things in the chat. That is all for today. And again, as you know, I have conversations with individuals. I’ll just jump on here once a week and I’ll share that information with you. Have a wonderful week. Take care.
