Compound is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it. – Albert Einstein
What is it?
In 2009, the Tax Free Savings Account (TFSA) was introduced by the Conservative government as an additional tool to help Canadians shelter investment income from taxes. The name is a misnomer – while the account is intended for savings, it is primarily a tax sheltering tool as any gains made in this account will always be tax sheltered. Unfortunately, most Canadians aren’t using it this way… they’re using a TFSA as a savings account and not maximizing their contributions. Here is an outline of the contribution schedule to date:
| Year | TFSA Annual Limit | Cumulative Total | Invested* |
| 2009 | $ 5,000 | $ 5,000 | $ 5,300 |
| 2010 | $5,000 | $ 10,000 | $ 10,918 |
| 2011 | $5,000 | $ 15,000 | $ 16,873 |
| 2012 | $5,000 | $ 20,000 | $ 23,185 |
| 2013 | $ 5,500 | $ 25,500 | $ 30,061 |
| 2014 | $ 5,500 | $ 31,000 | $ 38,061 |
| 2015 | $ 10,000 | $ 41,000 | $ 50,945 |
| 2016 | $ 5,500 | $ 46,500 | $ 59,831 |
| 2017 | $ 5,500 | $ 52,000 | $ 69,251 |
*Assumes a 6% increase from Canadian market
This means that if you’re someone who has never opened or contributed to a TFSA (you’re a newcomer to Canada or you just weren’t in a position to contribute), you have a limit of $52,500 to maximize your TFSA in 2017. If you just turned 18, your contribution limit starts the year you turned 18.
What’s the interest?
It depends on your investment strategy! Are you keeping your money in a registered high interest savings account? Is it a GIC? Are you trading equities with your TFSA? It all depends!
Can I take my money out?
You certainly can… but please don’t! While it’s called a savings account, I see it more as a tax sheltering mechanism. This means that when your money grows in the registered account, your contribution limit grows as well! If you leave it in and let it grow, taking advantage of compound interest, when you’re 70 years old and want to use this money, you won’t be paying any tax on it (as opposed to your other tax sheltered retirement accounts, like you’re RRSP or LRSP)! TFSAs have a lot more versatility than a registered retirement account, in this regard. You can take the money out whenever you want and the contribution limit will just carry over to the next year. This means that if you have $52,500 in your TFSA (the limit for 2017) and you withdraw $2,000 in 2017, you will need to wait until 2018 to replace that $2,000 that you withdrew. Keep in mind, in 2018, you’ll (hopefully) have a new contribution amount, likely in the $5,500 range. If you wanted to maximize your annual contribution, you could recoup the $2,000 that you withdrew the year before and deposit a possible $7,500 total.
The case for leaving your money there
The tragedy is that the one thing most investments need is time. A passive equities investor really only needs to get a head start at buying a healthy index of the major North American exchanges and they can sit back and watch their investments grow at a solid 6% average (I’ve seen 8.5% but a conservative estimate is generally 6% return). An investor who maximized and passively invested their contributions since 2009, as of today (2017) would have made $69,251. They’ve invested their way to a $17,251 window of tax free room, compared to the $52,000 of base contribution. For a more extreme strategy, you can also consider small cap stocks. The Financial Post published a great article about this here (http://business.financialpost.com/personal-finance/savings/not-for-the-faint-of-heart-the-500000-tfsa-and-whether-its-right-for-you).
What tax do I pay on it?
Another half misnomer… while you don’t pay tax on any of your earnings made by your TFSA (that’s why it’s tax free!), the funds you deposit to your TFSA are after tax funds. This means that you’ve already paid tax on this money but after it’s deposited into this account, it will never be taxed again! Beware of non-Canadian holdings with this registered account though. The Tax Treaty with the United States applies to retirement funds (like your RRSP or LRSP/LIRA) but not to the TFSA, so if you invest in American stocks, you will need to pay withholding tax on it. For simplicity, it’s best to keep Canadian equities and funds in your TFSA.
How’s my TFSA?
I didn’t always invest my TFSA with the creative zeal I have today. While I’m getting about 6% now, I used to get around 2-3%. Right now, I have about $63,000 in my TFSA and I’m hoping to $100,000 before within the next four years by maximizing my contributions and keeping my current mix of Canadian ETF and equities. As is the case with most Canadian investors, I have a mix of lumber, banks, oil and gas, technology, composite and for good measure, a REIT. I plan on leaving my TFSA for a long time, so all my ETFs have very low fees – these fees really add up over time, especially 20-30 years!
A little bit more about fees
The average financial advisor or mutual fund charges 1-2% in fees per year. This fee is typically paid for the service you’re getting from someone either directly and actively managing the way your money is invested (re-balancing your portfolio or adjusting for higher yields throughout the year) or indirectly through someone managing the fund or funds your money is investing in. Here’s the table above, but with the fees you would pay:
| Year | TFSA Annual Limit | Cumulative Total | Invested* | Fees** |
| 2009 | $ 5,000 | $ 5,000 | $ 5,300 | $ 106 |
| 2010 | $5,000 | $ 10,000 | $ 10,918 | $ 324 |
| 2011 | $5,000 | $ 15,000 | $ 16,873 | $ 662 |
| 2012 | $5,000 | $ 20,000 | $ 23,185 | $ 1,126 |
| 2013 | $ 5,500 | $ 25,500 | $ 30,061 | $ 1,734 |
| 2014 | $ 5,500 | $ 31,000 | $ 38,061 | $ 2,495 |
| 2015 | $ 10,000 | $ 41,000 | $ 50,945 | $ 3,514 |
| 2016 | $ 5,500 | $ 46,500 | $ 59,831 | $ 4,710 |
| 2017 | $ 5,500 | $ 52,000 | $ 69,251 | $ 6,095 |
*Assumes a 6% increase from Canadian market
**Assumes a 2% management fee compounded, accumulated
I included a 2% fee in the table above but the real argument for low fees comes into play once you’ve been accumulating fees after 20 or 30 years, as I’m advocating in my article. I want you to leave your money there but after 20 years (2029), you’ve paid a total of $42,000 in fees. After 30 years (2039) that jumps to $116,000! That’s tax free money… just gone. Poof.
Most ETFs have a management fee under 1% and often, it’s a fraction of that. Most of my ETFs have fees of 0.1 or 0.2%. Better yet, equities don’t carry any fees (except for the commission you pay to buy them)! If you effectively set up your Dividend Repayment Plans (DRPs), then you will be optimizing your returns and keeping most of what you earn. That’s called smart investing over the long term. Turns out, Einstein knows his stuff!