A Tax Free Savings Account (TFSA) can be a great way to make a bit of extra money each month through compounding interest, tax free. If you have some money in a regular savings account and you live in Canada, open a TFSA and transfer as much as you can into the TFSA (Watch out to not transfer more than your allowed contribution room). If you don’t have any savings, I’d suggest putting at least 10% of your income away into your TFSA for every pay cheque you get. Started in 2008, the contribution room increased every year and will continue to do so. Currently, in 2016 the max contribution room is $46,500. In 2017, it will go up by $5500. If you have a regular savings account, the interest earned will be taxed after $20.
Compounding interest is incredibly powerful and it basically means interest that is earned from an amount of money that exponentially grows as time goes on. When the interest earned is kept in the account, it starts to work with the original sum of money, which continuously grows, earning more and more interest. This being done in a TFSA is even better, because all interest earned is 100% passive and tax free. My suggestion is to open an account with Tangerine which is a no fee banking service where you can set up a TFSA and start automatically contributing to it each month. From there, look into the investment options they have. Their fees for mutual funds for example are extremely low compared to other banks and it’s completely managed by them. They have low risk and higher risk investments to choose from, but all have performed well each year. Take on risk based on your age. The younger you are, the more risk you should take. Between 18-35, I think taking the higher risk option at Tangerine is the way to go because mutual funds have proven to perform well if the investment is over many years. If you’re investing for only 1-4 years, you’re better off taking a lower risk investment as your chances are higher of hitting a market crash because you’re only in the investment for a few years; there hasn’t been time to ride it out for the mutual fund to grow again.
Here’s some info you should know about Tax Free Savings Accounts
You have to be at least 18 years old
Unlike an RRSP, you can keep contributing after age 71 to your TFSA
You can withdraw money at anytime without penalty, tax free. you won’t be able to put that amount back in, until the following year, unless you have other contribution room left. There are penalties if you contribute too much, so be careful.
You can use your TFSA to invest in things like bonds, GICs, mutual funds, or stocks to name the common ones.
If your spouse is not taking advantage of their TFSA, you can double up on tax-free income generation by opening a second TFSA in their name.
If you don’t have a TFSA, my recommendation is to add it to your to-do list, or put it in your calendar and get one as soon as you can to start taking advantage of its power!
Contributor:
Will Bartlett