Using a TFSA to Become a Millionaire

On 03/02/2010, in Investment Strategies, by Jordan Wilson

But only if you are Canadian.

This Financial Post article discusses Gordon Pape’s book, The Ultimate TFSA Guide.

I strongly recommend taking advantage of the TSFA program if you are a Canadian adult.

Under today’s tax law, I see no downside for investors. Set one up soon.

What is a TFSA?

TFSA stands for Tax-Free Savings Account. In Canada, individuals age 18 and older and in possession of a valid Social Insurance Number may contribute up to $5000 annually (limit will be indexed upwards for future years) into a TFSA account.

Contributions are not tax-deductible, so this differs from Registered Retirement Savings Plans (RRSP). Any unused amounts may be carried forward for future use.

Earnings within the TFSA accrue tax-free, like the RRSP. But unlike the RRSP, withdrawals are not taxed (at this point in time, who knows what the future tax laws hold in store) in the hands of the individual.

Also, there are time limitations on keeping an RRSP open. There are no such time limits with a TFSA. You could start one at age 80 if you so desire.

Investment possibilities are extremely diverse, although there has been a slight tightening to prevent abuses. I would recommend including investments that are taxed at the highest tax rates as you pay no tax on income earned inside the TFSA. That said, right now $5000 may be all you can save annually, so feel free to use the account for all your investments.

Withdrawals may be used for anything. This differs from the Registered Education Savings Plans (RESP) which require withdrawals to be used for educational purposes. Also, amounts withdrawn may be repaid into the account at a future date without penalty.

If you die before withdrawing all capital, balances within the TFSA may be rolled over (i.e. transferred) tax free to certain persons.

With a TFSA there may be set-up or administrative fees charged. As I have often wrote, money paid to others cannot compound for your own benefit. Before setting up an account, shop around to ensure the fees charged are reasonable.

For example, you set up a TFSA on February 1, 2010, so you are allowed a 2010 annual contribution of $5000. On March 1, you deposit $4000 into the TFSA. On December 1, you withdraw $2000.

For 2011, you are allowed to deposit the $5000 annual limit. You are also allowed an extra $1000 to reflect the unused contribution space from the prior year. Because you withdrew $2000 in the prior year, you can also add that back if you desire. This allows you to potentially contribute $8000 legally in 2011.

The Ultimate TFSA Guide

The crux of Gordon Pape’s book appears to be:

• Start immediately: This means at 18, which happens to be the age of my own daughter. As Pape says, “The more years your money can grow tax-sheltered, the wealthier you will be.”

• Contribute as much as possible: That means $5,000 per year for now.

• Contribute early: Since another $5,000 in contribution room becomes available at the start of each new year, early January is the best time to put money in.

• Aim for a higher return: Don’t be overly conservative if you are under 50.

Sounds a lot like my three post discussion on the Power of Compounding. If you have not reviewed them, I suggest you do so here, here, and here.

It was recently pointed out by a commenter that, according to a 2008 survey, 2/3 of all Americans do not understand the concept of compound returns. If you fall into that group, the linked posts will help you better understand the concept and why Mr. Pape’s points should be followed.

I do not usually recommend specific courses of action in a post. Everyone is unique and decisions that are correct for one person may not be for another. But in this case, I think that the overwhelming majority of Canadian adults should take advantage of the TFSA program.

Please consider using a TFSA. It is an excellent means to achieve financial success.

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1 Response » to “Using a TFSA to Become a Millionaire”

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