I did a presentation at work today and touched on the TFSA. There was some confusion about how it works so I thought I’d clear that up for anyone else wondering what they can use it for.
The TFSA is somewhere you can put money and it will grow tax free. What does that mean? Well, when you get interest from the bank it is taxed. If you make some money in the stock market, its taxed. Collect dividends? They’re taxed too! The TFSA is a shelter where you can collect all these types of profit tax-free.
You get $5000 per year of new money that you can put in. If you don’t put the full amount in it will carry forward to future years. Now, what most people don’t realize is that you can grow your contribution room as your investment grows. Here is an example:
You put $5000 into a TFSA and invest that money in a company that specializes in high-end massages for pet monkeys. Other people didn’t have the foresight you had into the pet monkey luxury service market, so when you bought the shares they were just pennies each. Surprisingly enough to everyone but you, pet monkey massages take off and everyone from Shaq to Paris Hilton is getting their pet monkey a massage. Suddenly your shares are worth several dollars each!
The $5000 you originally put in is now worth $100 000. Way to go! Now, you want to celebrate by rewarding yourself with a shiny new sports car. But what happens to your contribution room if you take that money out? Does it drop back down?
Thankfully, it does not! You can go buy your $100 000 sports car with that cash and your contribution room will be $105 000 the next year ($100 000 plus the $5000 for the new year).
It is this fact that makes me argue heavily in favor of using your TFSA for investment purposes. If you have more than your contribution limit invested currently as many of our parents would then I would recommend they move over their most speculative or high-risk investments to their TSFA. It is that type of investment that is most likely to double or triple in value. This saves you more money on capital gains and also increases your contribution room for the future when you want to shift to purely safe investments which will again save you more money as you collect dividends, etc.
So if you ask me, use your savings account to save. Use your TFSA to invest, and if you have a large diversified portfolio then put the high-risk shares in your TFSA.
When you’re a billionaire feel free to share some of the wealth. Or buy the Phoenix Coyotes and move them to Hamilton. I’m cool with that too.
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