When the tax free savings account was introduced back in 2009, it was mainly promoted by the banks as a high interest savings account. Since then, people have realized the tremendous potential of the TFSA for a variety of savings goals. Let’s take a look at three ways to save inside your tax free savings account:
Playing It Safe
Just like the banks originally intended, many people are comfortable just playing it safe with their tax free savings account. It’s the perfect place to build an emergency fund since it’s simple to make monthly contributions to a savings account within your TFSA.
The nice thing about using your TFSA as an emergency fund is that you’re able to withdraw your money relatively quickly when you need it, but the extra steps required to access your funds from within your TFSA should deter you from making frivolous withdrawals.
You can withdraw money at any time, and you won’t be required to pay tax on the interest earned inside your tax free savings account. Any money withdrawn will be added to your TFSA contribution room the following year, which is perfect for replenishing your emergency fund.
Short Term Goals
Short term goals can be defined as something 1-3 years in the future. Whether you are saving up for a new car, a vacation or a downpayment on a house, your TFSA is a great vehicle for your short term savings goals. Instead of a high interest savings account paying a measly 1% interest, if you have a specific savings goal you should consider a GIC, which are currently paying up to 2.6% interest on a 3 year term.
If you’ve already earmarked your savings towards a specific goal, especially for a downpayment on a house or to finance education expenses, the stock market is probably the last place you want to put your money. Preservation of capital is more important than risking your money trying to earn an extra few hundred dollars.
While fixed income products like GIC’s aren’t the sexiest investment out there, you’ll have the peace of mind knowing that your savings are still intact when you need it.
Taking a Long Term Approach
Your tax free savings account has great potential as part of your long term savings strategy. While most people viewed the $5,000 annual contribution room as too low for any significant investment opportunities, experts are now accepting the tax free savings account is a viable alternative to making RRSP contributions. While that calculation depends on your specific tax situation now and when you reach retirement age, the TFSA can certainly be used to complement your RRSP.
When you consider that along with your spouse you have $10,000 in annual contribution room, the tax free savings account becomes even more attractive when investing for the long term. And when you compare investing in a TFSA vs. a non-registered account, the fact that you don’t have to pay capital gains tax is a clear advantage for the TFSA. Although it’s worth noting that the TFSA is not eligible to claim a capital loss either.
By maximizing your TFSA contribution room to invest in dividend stocks or REIT’s each year in your 20’s and 30’s you can build up your investment portfolio to a significant amount when it’s time to retire.
Tax Free Savings Account – What’s Right For You?
No matter how old you are, or what you’re saving for, you should be taking full advantage of your tax free savings account. It’s a great savings vehicle for building your emergency fund, and can be used to preserve capital for short term savings goals like a downpayment on a house or for a new vehicle.
Finally, if you have those bases covered and have figured out how to invest your money for the long term, you can use your tax free savings account as a stand alone or as a complement to your RRSP when investing for retirement.
How do you make the most out of your tax free savings account?