In 2009, the federal government introduced tax-free savings accounts.
When they were first introduced, I don't think most people understood the power of these accounts and the incredible ability to compound money on a tax-free basis and to withdraw the money without triggering any tax.
Since 2009, tax-free savings accounts have been readily embraced by Canadian families as an important component to their financial planning and asset accumulation goals.
Unfortunately, there is an important misunderstanding about tax-free savings accounts that continues to linger.
This understanding, which is false, is perpetuated by the description of these accounts themselves. Embedded in the name is the term, "savings accounts."
It's the use of this term (savings account), that creates confusion, and unfortunately, this confusion leads to poor investment decisions made for these accounts and subpar long-term performance.
How do we fix this problem?
To start with, let's change the name. We should call these accounts – "tax-free investment accounts“
By taking out the term savings you realign your investment priorities when it comes to tax free savings accounts. You’ll start seeing these accounts as something more than a place to accumulate cash and savings. You'll also start to look at this vehicle as a long-term
When I meet with clients and prospective clients alike, I'm constantly astounded by the amount of money sitting in tax-free savings accounts invested in high-yield savings and variable-rate cash accounts.
These savings accounts are earning next to nothing, and when you take into account the fact that we live in a world where inflation is a reality, these accounts are not earning sufficient yields to cope with the negative impacts of inflation.
If you're earning 2.5% in your savings account and inflation is averaging 2.5% your real return is 0%! This is a great way of going broke safely!
Let’s say that you max out your $6000 year allowable TFSA contribution for 20 years. In 1 scenario your account had a 2% yield and in the other, it had a 4% yield – Look at that difference with just the power of compounding. It’s a $200K difference. That 200K growth within a TFSA would be TAX FREE.
The true power of TFSA's is the fact that money is compounding on a tax-free basis. If you're earning anywhere from 1% to 2% on your savings, you aren’t really compounding much tax free!
So let's start changing the conversation.
First, when you hear the phrase, "tax-free savings accounts", in your mind think "tax-free investment accounts.
When you do this, you begin to free up your thinking around the kind of investment options that will be available to you.
Maybe it's no longer about savings accounts and term deposits or GICs. Maybe the conversation begins to involve balanced mutual funds, growth mutual funds, ETF strategies, mortgages, or high quality stocks in your tax-free savings account.
Before that conversation starts, it's important to be clear on what your objectives are for the funds that you are allocating toward your tax-free savings account.
This clarity comes about by working with a certified financial advisor and creating a customized financial plan.
Are you trying to save money for short-term expenses that may be coming up over the next year? A car, an upcoming wedding or holiday?
Is your retirement less than 10 years down the road and so you are trying to save money to supplement your retirement cash flow? You feel like there may be a gap between your pension and actual income needs
Have you been maximizing your yearly tax-free savings account contribution opportunities, but you are in the enviable position of not needing your tax-free savings account assets for your own needs. You view these accounts as legacy assets that will eventually go to your children or grandchildren.
What investment strategies will be most appropriate for you?
What are your short and long term financial goals.
This clarity will help you to make sound financial decisions around how to invest your tax-free savings account dollars.
How are you using your TFSA? Be sure to discuss this with your advisor or contact our office in order to set a time to discuss your personal situation.
This video elaborates on this topic and provides addition information for you.