For Canadian investors, the new year brings more contribution room to your tax-free savings account. Kind of a big deal, and great news for those of us who want to shelter more of our money from tax. When TFSA’s were first introduced, they were a good idea, but the impact was small because you could only contribute $5,000 per year. Now that they’ve been around for a decade, that amount has continued to grow, and the 2020 TFSA total contribution room is $69,500. Factor in investment returns, and there are more than a few people who are looking at six-figure TFSAs.
If you haven’t opened a TFSA or aren’t sure if it’s right for you, then you’re in the right place. I’m going to tell you why it’s such a valuable tool and how maxing out your 2020 TFSA is almost always a good idea if you can.
Like anything created by the government, the TFSA contribution limits are not that simple. Take a look at the table below, and you’ll notice some changes over the years. It started as a flat $5,000 per year, but with the promise it would grow with inflation (rounded up to the nearest $500). However, there was one outcast year where the Conservatives increased the limit to $10,000. None of that is significant though; the total is what matters.
|2009 - 2012||$5,000/year|
|2013 - 2014||$5,500/year|
|2016 - 2018||$5,500/year|
|2019 - 2020||$6,000/year|
You have to be over 18 to earn contribution room. If you were under 18 in 2009, then you’ll only start building up room in the year you turn 18. It doesn’t matter if your birthday is in January or December; if you turn 18 at some point in that year, you get the room.
TFSA contribution room also carries over, so if you’ve never contributed, you can do the maximum all at one time. And, if you make a withdrawal, you can recontribute the full amount you withdrew the following calendar year. Pro tip: if you need to make a withdrawal, but it’s not time-sensitive, it’s better to wait until the end of the year so you can replace it faster.
Why TFSA’s Are Good
A lot of people like RRSP’s because they give you a tax refund, so it’s almost instant gratification. TFSA’s don’t do that so they can seem less desirable. However, that tax refund sounds a, but the catch with RRSP’s is you have to pay the tax back when you withdraw the money (hopefully in retirement when your income is lower). With TFSA’s, you don’t get that instant refund, but you can pull the money out at any point in the future and pay no tax. If you did that outside of a registered account, you would have to pay tax on dividends, interest, and capital gains regularly. With TFSA’s, you can earn all those things and never pay a penny of tax on it.
If you’re just getting started with TFSA investing, then that might not sound like a big deal. But keep adding and growing it, and it will be apparent very quickly.
How to Use your TFSA
The great thing about TFSA’s is how flexible they are. Because you aren’t paying tax on withdrawals, you can use them to save up a downpayment, for a vacation, for that pony you always wanted, or for your retirement. With the total contribution room growing each year, their popularity as a tool for retirement savings will continue to grow. When I retire, I will likely receive income from both my RRSP and TFSA, along with CPP and OAS.
There’s no right way to use your tax-free; it depends on what you are currently saving for.
One thing to note is that you can have more than one TFSA. Potentially you could earmark each account for a different goal. You want to make sure you don’t get confused though. The penalties for overcontributing are super steep, so make sure you are tracking your contributions closely.
How to Invest Your 2020 TFSA
This is a hard question to answer because it really depends on what the money is for, how long it will be invested, and your risk tolerance.
Like an RRSP or a non-registered account, your TFSA isn’t an investment; it’s an account to hold investments. You can buy stocks, bonds, mutual funds, ETF’s, GICs, etc. or you can hold cash. The thing is, in order to get the benefit of a TFSA, you need the investments you hold to grow. Cash, while safe and easily accessible, isn’t going to grow. You’ll be lucky to earn a portion of a percent on it. That’s why I recommend you use your TFSA for investments you hope you will grow, and keep your cash holdings (like your emergency fund) separate.
If you are currently focusing on paying off debt and building an emergency fund, then it’s not a bad idea to use your TFSA. But as soon as you are able to start investing, then you’ll want to switch tactics use your TFSA for the investments.
As for timing, now is always the right time to invest. If you have the funds available to top-up your 2020 TFSA then go for it! If you don’t, then invest when you do. Maybe this means waiting for your tax refund, or an annual bonus, or making monthly contributions that align with your paycheque. Don’t hold off on investing because you think you can time the market. You can’t. None of us can.
- Total contribution room for TFSA’s in 2020 is $69,500
- You pay no tax on the money in your TFSA; not now and not in the future
- You can hold all the same investments you can hold in your RRSP
- Use your TFSA for investing and not to hold cash
- Invest when you have the funds available
Do you have questions on the best way to use your 2020 TFSA? Hit me up in the comments, and I’ll happily answer them. Or maybe you’ve been contributed to your TFSA from the very beginning and want to share your success!
This post was proofread by Grammarly.