3 Keys to Understanding and Optimizing your Tax Free Savings Account

Last time I wrote about understanding and mastering your TFSA contribution room. This time, I’d like to write about making the most of your TFSA.

Here are 3 keys to using your TFSA efficiently.

The TFSA - Tax Free Savings Account - is an incredible tool here in Canada. Although the TFSA sounds like a savings account, based on its name, it actually has much more opportunity than that. Although it certainly can be used as a savings account...

Think of it like your Tax Free Investing Account.

Or your Tax Free Retirement Account.

Or your Tax Free Help you Reach Your Goals Account.

The point is, it doesn’t need to just be a savings account like you have at the bank.

Here’s why:

A TFSA is just a plan type. Like an RRSP. Because of that, you can invest within your TFSA just like you would another retirement account.

Because of this, the TFSA has a significant opportunity for long-term growth. Like discussed during my last post, your contribution room is limited; however, the lifetime maximum already totals $88,000 (if you are old enough) in 2023, with more room to come in future years.

In fact - most Canadian’s aren’t using their TFSA to its fullest extent. Recent statistics from the Canada Revenue Agency from the 2020 contribution year show that across all income levels, the unused TFSA contribution room exceeded the market value of the plan, except for those in the highest income bracket.

So here are 3 ways to make the most of your TFSA:

1) Include your TFSA in long-term financial planning.

Just like other long-term accounts, like RRSPs or pensions, your TFSA can be included in your long-term savings. Rather than simply using savings products or GICs, your TFSA can be invested just like an RRSP, in stocks, bonds, mutual funds, ETFs, etc. Your same investment philosophy for your retirement account can apply to the TFSA. It is simply just a different plan type.

Caveat: Ensure your investments are suitable for you. I am not advocating for one or the other, simply making it aware that investment options in a TFSA are flexible.

For reference, if your TFSA was maxed today ($88,000), with a 5% annual rate of return, over 30 years, that amounts to $380,000 at that time. A significant amount of money!

2) Understand the long-term tax efficiency of the TFSA

There are a couple of key benefits for the long-term tax efficiency of using your TFSA. The first one is understanding taxable income later in life. As you start to withdraw from your portfolio, your income will come from a variety of sources. CPP, OAS, RRSPs, pensions, TFSAs, etc. Many of these sources will be taxable, but TFSA withdrawals will be tax-free.

The fact that TFSA withdrawals are tax-free comes in handy for income tests or limits. Like OAS. After a certain amount ($81,761 in 2023), OAS starts to be clawed back, which means that the amount you receive is reduced. TFSA withdrawals won’t add to your income thus not increasing the likelihood of any clawback.

The second long-term efficiency is the estate benefits. Your TFSA can have a named beneficiary, whether that is your spouse, children, or someone else.

Your TFSA will pass along tax-free to this named beneficiary and avoid probate.

Further, your spouse can be named as a successor holder on your account. This means your spouse “inherits” the TFSA as if it were theirs, adding what was in your TFSA to theirs. For example, if your TFSA was maxed out and you were to pass away, your spouse could inherit this account in addition to their TFSA and its associated contribution room.

My colleague Evan Neufeld, CFP? recently discussed this on his podcast where this allowed someone to make a $187,000 TFSA contribution. You can check it out here.

3) Don’t waste your contribution room.

Losses in a TFSA can’t be reused. Using an extreme example, if you have maxed your TFSA, but put it all in speculative investments which become worth nothing, you do not earn this contribution room back. It is lost forever.

Considering long-term growth potential and the lost tax-free estate benefits, losing your room can be significant.

Be wise with your TFSA investments.

Make the most of your TFSA:

So in conclusion, by understanding your TFSA, and using it properly and efficiently, you can increase your lifetime spending potential, increase your tax efficiency later in life, and have significant estate benefits.

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