How to PROPERLY Use Your TFSA to Retire Sooner

Retire early with a completely tax-free income


I’m talking about your Tax-Free Savings Account. Yes, most of us have one, but are you using it the proper way?

Most people think that it is what the name implies – a “savings” account, where you park some cash until your next vacation or kitchen reno. This perception is completely wrong. In fact, it's one of the greatest wealth-building tools available to Canadian's, regardless of your income level. Let me explain.

If you're already familiar with how the TFSA works click here to skip the basics and go straight to how you SHOULD be using it.


First, the basics

Before I explain exactly how you should be using it, let’s quickly recap the basics.

Most types of investments can be included in your TFSA, including stocks, bonds, GIC’s, cash, mutual funds, and ETF’s. The minimum age to open a TFSA is 18 and you must have a social insurance number.

Each year you can add an additional $5,500 to your TFSA (with the exception of the years 2009 through 2012 where the limit was only $5,000, and 2015 where you were allowed to add $10,000). The following chart shows the cumulative total since it’s inception in 2009:


As of the year 2018, you can have up to $57,500 in your Tax-Free Savings Account, even if you’ve never contributed in previous years, or didn’t contribute the maximum amount in those previous years.

Everyone has this space, no matter what. Furthermore, you can carry forward any unused contribution room indefinitely into future years, so it’s never lost if you don’t use it.


The low-down on taxes


Any contribution you make to your TFSA is made with money you’ve already paid tax on, so unlike an RRSP, the money you contribute can’t be written off as a tax deduction. BUT, also unlike an RRSP, there are no tax penalties for taking money out of your TFSA, which means you can take cash out at any time of the year without having to pay tax on it. 


Q: "If I take money out will I lose my contribution room?"

Absolutely not! All the government asks is that you wait until the following year to put the money back in.

For example, if you’ve maxed your TFSA at $57,500 and take out $10,000 to buy a car, you can put that $10,000 back into your account on January 1st of next year.

In addition, come January 1st, you’ll also get another $5,500 in contribution room added to your cumulative total, so actually, you can put $15,500 into your TFSA on January 1st. 

Note: there is a small tax penalty if you over contribute; make sure you're aware of how much you’ve already contributed and prevent going over your TFSA limit.


Here’s what makes the TFSA so great, and how you SHOULD be using it

We’ve covered the basics, now let’s talk about how you should be using it to make a mass amount of tax-free cash. 


The key to remember is that taxes don’t apply to any capital gains you make inside your TFSA. What does this mean? We know you can hold lots of things besides cash in your account, including stocks.

Let’s say you get a hot stock tip from your Uncle Bob at the family BBQ and you end up getting in on the ground floor of the next Apple. If the stock price goes through the roof you can literally make unlimited profits in capital gains and they are entirely tax-free! 


Q: "I picked a few good stocks that went up, I sold and made a profit. Now I have $75,000 sitting in my TFSA. What happens to my contribution room and will I get penalized for being over the limit of $57,500?"


Here’s the beauty of it: no you won’t get penalized for being over $57,500.

The $57,500 limit only applies to contributions you make with money from outside your TFSA. Meaning, anything you make within your TFSA is fair game and simply pushes your contribution limit ceiling higher.

In our example above, if your new TFSA value is $75,000, you can choose to take the entire $75,000 out of your account completely tax-free, and on January 1st of next year put the full $75,000 back in, along with an additional $5,500 of new contribution room ($80,500 in total!).

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Remember: whatever amount you take out, you can put back in the following year, regardless of the amount you initially took out.

Look at the bigger picture

Since you can hold investments with the potential for large returns (like stocks and ETF’s) the biggest mistake most Canadian’s make is using their TFSA as a savings account and simply holding cash.


With a sound investment strategy, you can literally grow your account into millions of dollars. When you're ready to retire, sell any risky stuff and put the profits into safe, high yield investments paying a 5% to 7% annual return.

Your dividend cheques will roll-in each month and pay you a monthly income that can be withdrawn from your TFSA tax-free without ever spending a dime of your principle. 

For example, assume you've managed to grow your account to $1,000,000 over the years. You now sell any risky investments (tax-free) and spread the $1,000,000 across a variety of safe, fixed-income, investments that pay a nice return of 5% ($50,000/year), tax-free.

Not a bad little income! Keep the $1,000,000 invested in the safe stuff without ever spending it and you’ll have a tax-free monthly income for life. 


More great features you MUST know about

If you already own stocks and investments in a non-registered account and want to move them into your TFSA, you don’t have to sell them and then buy them back inside your account.


Simply call your bank or investment broker and ask them to transfer your stocks as an ‘in-kind’ contribution to your TFSA. You’ll pay a small capital gains tax on the value of any gains already realized on each investment, but this is a small price to pay knowing that any capital gains going forward are completely tax-free


Q: "If I am going to sell something at a loss am I better to sell it in my TFSA or cash account?"

Sell it in your cash account first, then transfer it to your TFSA. You can't apply capital losses towards the offset of capital gains within a TFSA. 

For capital losses that occur in your cash account, you can go back up to 3 years and apply them to any gains. Otherwise, a capital loss can be carried forward indefinitely. 


Did you know: you can open a TFSA for US dollars and US investments?

Yes, you heard that right! You can buy and sell US stocks as well as hold US cash inside your TFSA – great if you want to get in on Apple, Google, or any other US stock we can’t buy here in Canada (not to forget the favorable exchange rate!). Simply call your bank to set it up.


Q: "Do I have to pay US taxes on my US investments?"

Any capital gains you make on US investments inside your TFSA are tax-free in both Canada and the US.

The only tax you pay is 15% on any dividends from US investments, which is automatically deducted from your dividend cheques, thus, no need to pay additional tax or worry about reporting US investments on your tax return – super easy!

Key takeaway: stop using your Tax-Free Savings Account as a “savings” account – this is one of the biggest mistakes Canadians can make when it comes to their financial future.

Use it to grow investments like stocks and ETF’s – investments with high growth potential.

Over the years you can amass a fortune. When you’re ready to retire, sell any risky stuff and spread your cash across safe, fixed-income investments; you can live on monthly dividend cheques tax-free without ever spending the principle!


Are you using your tax-free account the proper way? Let me know in the comments below.

Disclaimer: The views expressed are provided as a general source of information only and should not be considered to be personal investment advice or solicitation to buy or sell securities. Investors considering any investment should consult with their investment advisor to ensure that it is suitable for the investor’s circumstances and risk tolerance before making any investment decisions.

Before you invest be sure to register for my Building a Bulletproof Portfolio investing workshop, and get the complete guide on How I built a winning portfolio that sailed through the 2008 stock market crash without losing a dime.