How does a TFSA work?

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Andrew Goldman

Andrew Goldman has been writing for over 20 years and investing for the past 10 years. He currently writes about personal finance and investing for Wealthsimple. Andrew's past work has been published in The New York Times Magazine, Bloomberg Businessweek, New York Magazine and Wired. Television appearances include NBC's Today show as well as Fox News. Andrew holds a Bachelor of Arts (English) from the University of Texas. He and his wife Robin live in Westport, Connecticut with their two boys and a Bedlington terrier. In his spare time, he hosts “The Originals" podcast.

A TFSA is a government-sponsored account that was first introduced in 2009. It allows you to save or invest money without paying tax on the returns. In other words — it’s a gift from the government.

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But there’s a limit to the amount of gifting the Canadian government will do. You can only put a set amount of money into a TFSA each year, it’s known as a contribution limit and it varies from year to year. It’s wise to know this year's limit and past limits before you open a TFSA and start contributing. That’s because over contributing comes with a nasty penalty — 1% of the excess contribution every month until it’s withdrawn. You’re in luck if you’ve never contributed to a TFSA before now! Unused contributions roll over each and every year from your 18th birthday or 2009 (whichever came last). This means there’s no hard deadline for contributing to a TFSA.

If you already have another government sponsored account like an RRSP — great! Just don’t let that put you off getting started with a TFSA. You’re probably best served to have both a TFSA and an RRSP as they’re both designed for very different things. One for retirement savings, the other for anything other than retirement savings. Unlike retirement accounts, you can withdraw funds from your TFSA at any time without penalty. This makes them ideal to save money for anything from a trip to Jamaica, a Rolex, Porsche or whatever other nice thing you dream of buying in the not so distant future.

To open a TFSA you’ll need to have your social insurance number and date of birth along with some other personal details. You may also be asked to provide a few supporting documents. The process is relatively easy, particularly if you do it online. Thanks to the wonderful internet of things — you can open a TFSA online in a matter of minutes.

You’ll need to decide if you want to save or invest or save the money in your TFSA. When it comes to investing, you have a number of options. You can choose to invest in mutual funds, stocks and ETFs. If those things sound like a foreign language, then having an automated investing provider manage your TFSA will probably be an attractive option. They do all the leg work!

TFSA’s are a relatively new type of account and some aspects of the account have yet to be worked out. For example — how much you can actively trade within your the account. But, there’s one thing for sure, the account is not intended for dodging taxes, so be sure to follow all the rules that come with having a TFSA.

If you plan on opening a TFSA you should know exactly what you’re saving for and then choose to invest or save accordingly in order to help you achieve that savings goal. Historically speaking, the stock market (S&P 500) has often provided higher returns than saving. However, in order to have potentially achieved those returns, you’d need to have invested over a long time period and taken on more risk compared to saving. This makes a savings TFSA is ideal for money that you might need in the short term, for example, an emergency fund or next years vacation. A TFSA comprising of investments is an option to consider for long-term saving such as a deposit on a house you plan to buy in ten years.

Why? When it comes to investing, you’re well served to have a plentiful supply of one thing — time. The stock market fluctuated a ton in the past although it trended upwards over time (S&P 500). You need to be willing to ride out the ups and downs and probably play the waiting game in order to have a chance at winning. Contrary to the saying — history does not always repeat itself and strong performance in times gone by doesn’t mean the same trend will continue in the future.

The main benefit of a TFSA is its tax-advantaged nature — you don’t pay tax on any gains you make. While your contributions to a TFSA don’t reduce your taxable income and neither do any losses you suffer within the TFSA, the returns are not taxed which is very advantageous. If you're lucky enough to be in a position where you're maxing out your TFSA and RRSP and are wondering what's next then a personal investment account might be a good option.

Now that you know how a TFSA works, take the first step and open or transfer a TFSA to Wealthsimple. You’ll benefit from a personalized portfolio, low fees and smart financial advice. Get started with a Wealthsimple TFSA now.

Last Updated December 19, 2018

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