One of the most overlooked wealth building tools for Canadian educators are Tax Free Savings Accounts (TFSA). In this brief article I’ll explain why the vast majority of teachers do not have a TFSA and why they may be missing the boat for superior after tax investment returns.
First of all, what is a Tax Free Savings Account (TFSA)? A TFSA allows a teacher to contribute a maximum of $5000/year which shelters investment income earned from from federal and provincial taxes. You can check the Revenue Canada website for more details.
The vast majority of teachers do not have a TFSA because they believe that their pension plan is a sufficient form of savings for retirement. This is unfortunate because the TFSA is not a retirement account and it is not necessarily a savings account.
Savvy teachers have realized that the TFSA is actually an investment account meaning that you can own stocks or mutual funds. You can contribute $5000 each year and your income and capital gains will be sheltered.
The easiest thing to do is open up an online trading account with an online broker. Questrade was dubbed “the king of low cost investing” by the Globe and Mail’s Rob Carrick and they currently offer $50 rebates for new accounts opened by Canadian teachers.
Let’s walk through an example of how a teacher might benefit from a TFSA:
Alexander is a 27 year old teacher in the second year of his career. He has limited funds to invest and he doesn’t want to lock up his money in an RRSP. He opened up a TFSA with an online broker where he trades growth stocks. In 2010 he made a 14.6% return on his initial $5000 contribution. The entire gain of almost $750 was sheltered from taxes.
The TFSA gave Frank tremendous flexibility as he is mulling over whether to take a summer vacation or buy a new car. Fortunately, he can take out money from his TFSA and pay no penalties.