Monday, July 29, 2019
TFSA Benefits by the Decade
I truly believe the Tax-Free Savings Account should be owned by everyone here in Canada. For my many American followers, this is your Roth IRA, so substitute TFSA with that as they are very similar. This wonder investment vehicle allows your money to grow TAX-FREE and does not tax you upon withdrawal like a Registered Retirement Savings Plan would, (Traditional IRA or 401K in the States). You use “Post-Tax” dollars to fund it, meaning you have already paid the tax on that money. There are limitations on the amount you can put in it, ($6,000 in 2019), and you can catch up for years past, ($63,500 if you were over 18 since its inception in 2009). In this post, I will describe the usefulness of the TFSA for each decade of age you may fall into. I truly believe everyone should have one, no matter the age, so let’s explore that.
Under the age of 18, you cannot own a TFSA. Despite this, I believe parents SHOULD open one for their children. Why you might ask? It is an amazing way to teach kids about the world of investing. Compound interest is a beautiful thing. Albert Einstein called it the 8th wonder of the world and apparently, he was pretty smart. I can think of no better way to teach your children about compound interest than to open a TFSA for them. You can start by creating a company match program. By the way, you’re the company. That $20 for mowing the lawn or household chores can be thrown into the TFSA. Apply the “company match” for any money they decide to keep in there and not blow on candy. Just like in real life, withhold the match if they withdrawal. This is a great way to show the rules that exist in real life, but also show that patience and persistence pay off. As they transition into the teenage years and get real jobs, continue with their savings program within the TFSA. By the time they can own a TFSA, they might have a sizable amount in the one you created for them in your name.
The only thing on your mind might be the beer fund and babes, but the TFSA should take up some space in your head as well. This account can be your foray into the world of investing. In fact, the younger you are the more impressive the TFSA becomes. Why you might ask? Time baby, time. You have so much time to fund your TFSA that the magic of compound interest and the tax-free features can really do some damage. While your bank may tell you that the TFSA is a great place for your emergency fund, I disagree. This account is so powerful for your future goals, that I would suggest making it hands off if you can. Money in, no money out. I believe this because if this account becomes a money revolving door, you lose the time advantage you have. I suggest saving for your emergency fund in a general savings account that you have access to and keeping your TFSA at a different institution. You want your TFSA to grow over this decade and have some real meat on it by the time you are 30. You also want to “feel the market,” meaning know the swings that can and will happen in any given 10-year period. Why would you want to feel the ups and downs of the market? Over your lifetime you will experience a minimum of 3, 4, 5 or more market downturns. How you sweat those will determine your success in investing. Take a few “blows” while your account balance is low, so you know how it feels. Don’t be discouraged by the slow progression of your account. These are the building years that you will be rewarded with later.
Let’s get serious about investing. Let’s also not worry if we just started now. I didn’t start investing until I was 31. Life happens and your 20’s can be a wild time. It is important to educate yourself on the market. You probably have a stable job by now. You are probably done with school by now as well unless you’re a doctor. Now is the time to start making regular contributions to an investment account, the best one, of course, being the TFSA. You still have 3 decades until retirement age. This account can and hopefully should be very juicy by the time you hit 65. Many will tell you that the Registered Retirement Savings Plan is the way to go. While I do love the RRSP, funding your TFSA should come first. The reason is the Tax-Free nature upon withdrawal. One exception does exist and that is if you work for a company that provides you with a “matching program” for their group retirement plan. Always and I mean ALWAYS contribute up to the match. My favorite kind of money is free money, and only a fool would not take it. Beyond that, focus on trying to get to a point where you can max-out your TFSA contributions, (6K per year), and then dump into an RRSP is you can. If you have a fully-funded emergency fund, separate from your TFSA, and are maxing out your TFSA annually, you are sitting very pretty, and the future is bright!
If you are in your 40’s, you hopefully have a good grip on what you need to be doing to secure your financial future. One of those things should be maxing-out your TFSA contributions. While you will not have the powerful 7 figure possibilities that the 20 and 30-year old’s will have, you can still make this account reach some amazing levels by retirement. Combined with the RRSP you can hit some nice numbers by 65. At this point in your life, you probably are making a decent amount of money where the RRSP will have some solid benefits to you. With RRSP contributions you pay with “pre-tax” dollars, meaning any contributions lower your taxes paid for that year. Depending on what you earn, and what you contribute, this can really make a dent in your tax bill. Focus on efficiently contributing to the RRSP, but never neglect the power of the TFSA. While you might not get the nifty tax-deduction, you do get the tax-free growth and no taxes paid upon withdrawal. Also, if your work offers a Defined Benefit Pension Plan, (DBPP, or a “full-ride” pension), the TFSA should be your primary focus. Your pension plan will ding you with tax real good come retirement. It is not unusual that some people make almost or just as much in their retired years as they do in their working years because of government benefits kicking in as well. Your focus should then to be to have a fully funded TFSA and a paid-off home, (which is in fact another tax-free investment vehicle). An RRSP will be taxed upon withdrawal and if you make decent money in retirement, you will lose a good chunk of it to the taxman.
If you are in your 50’s, you hopefully have been investing for quite some time now. You may have a good chunk of retirement savings already built up. You are probably at your highest earning level yet and this will probably be your most lucrative, productive decade. The TFSA should be a part of your future planning during this crucial decade. You will not have the juicy amounts in it by retirement like your younger counterparts. You will be able to hit multiple 6-figure levels in it however and that will serve you very well come retirement. During your retirement years, you will need to be able to access large amounts here and there. It could be a car, or a new roof, or a family emergency. The TFSA can serve this purpose for you over the course of the rest of your life. The main goal right now, and into retirement, is to continue aggressively saving but also to avoid debt at all costs. This means that being “liquid” is important. The TFSA can serve this purpose for you. Another solid reason for a TFSA is to hold your potential large growth investments. If you like to dabble in the stock market with extra money, money aside from your retirement and emergency savings, the TFSA is a great place to do that. While you cannot put more than the contribution limit within it, (6K per year and $63,500 cumulatively), this amount can be used to purchase the investments that have higher growth potential. The reason this works well is because of not paying taxes upon withdrawal. Your “tax-deferred” vehicles should house the more moderate growth investments, while your TFSA can house your more aggressive growth investments. Food for thought.
The finish line is near. Maybe it isn’t. Maybe you don’t plan on retiring because you are able to work or love your job. Either way, just like in your 50’s, liquidity is an issue. This is not the time to be acquiring high, or even low, interest debt. Your focus should be to eliminate all debt as soon as possible if you have not done so already. Your goal should be to have a fully-funded emergency fund as well. At this point in life, I would recommend 2 years living expenses to cover you in case of an emergency. The reason that number is so high is that for many emergencies you will not be going back to work. If you are off work for 1 year due to injury or illness, there is a strong likelihood you won’t be going back to the same job. You might take a lesser role or even reduced hours. This could dramatically affect your retirement aspirations if you are not prepared. Having a fully stocked TFSA can help you if this were to happen. I want you to have several layers of protection including adequate insurance coverage, a juicy emergency fund, a fully funded TFSA, and strong retirement savings. Couple those with no debt, and you my friend, are made in the shade. Your TFSA will be the liquidity piece that can take you throughout the rest of your life so do not neglect to keep that baby full.
Remember our friends with those sweet pension plans? Well if you are in retirement you could be making a good amount of money still. Your house is fully paid off, you have no debts, you have good government retirement benefits, and you are also taking income from your RRSP. This my friends, is what I like to call, SWEET. What is not so sweet is your tax bill every year. The TFSA can be used as a place to dump money that you “don’t need.” You cannot avoid taxes on private and government pensions. You also cannot avoid paying it on RRSP withdrawals. What you can do though is put money into your TFSA every year to offset taxes and hopefully achieve growth. It is also a nice place to leave money behind because again, it’s tax-free. As an aside, any extra money can be put into permanent life insurance as well as a tax shelter. While I do not recommend Whole Life insurance in many cases, as a place to leave money to the next generation it is absolutely beautiful. At this point in your life, taxes are the biggest concern so make sure you have a good accountant and a good financial advisor working for you.
Many of the points on the benefits of the TFSA throughout the decades are interchangeable. Do not feel as if the reasoning only applies to your age or not to your age. The overarching theme is to focus on making this amazing investment vehicle as large as you can. When you want or need money later in life you will thank yourself for taking those steps.
“The avoidance of taxes is the only intellectual pursuit that still carries any reward.” – John Maynard Keynes