Tax is one of the main reasons preventing you from being financially independent. If you’ve taken a look at your paycheque, you know that taxes takes a huge cut from your pay and it can even take up to 52% of your annual income! However, the Tax Free Saving Account (TFSA) is one of the few and best tax saving vehicles in Canada. In this article, I will finally give you a solution to avoid paying taxes legally, through the TFSA and how to best use it to achieve your financial goals.
Employment Income:
Employment income was explained in depth in my previous article “Who do you ACTUALLY work for?”
Recap example: Your full-time job as a nurse you make an annual salary of $50,000 you have to pay taxes of about 30%. So at the end of the day, you are left with only $35,000 (50,000*70%). This is unfortunate, and sadly a TFSA can’t help you here.
Investment Income:
In last week’s article, “How to Invest to Make Money” I explained when we invest in stocks/shares, we get taxed on our investment income which includes capital gains and dividends.
This is where the TFSA can help you pay less tax.
Recap example: Let’s say you buy 100 Apple shares. Apple pays out a $1 dividend. So you receive $100 each year. This is considered investment income and it is taxed at an approximate rate of 29%. Therefore, in normal circumstances you will pay $29 (100*29%) of taxes.
However, a TFSA acts as a tax shelter for your investments. So any investment income from dividends or capital gains in the TFSA are TAX FREE.
Analogy:
Think of the TFSA as a pot that holds all your plants. The plants represent all your investments (stocks/shares). If your plants are in the pot, it protects them from the FIRE aka taxes. :’D
Comparison
Let’s look at a scenario that compares investments in a TFSA and not in a TFSA.
Example: You buy 10 Apple shares for $10. Each year Apple gives out a 5% dividend and you reinvest it to buy more shares. Looking at the chart and graph below, you can see a BIG difference in investing using a TFSA and not using a TFSA.
The tax free returns coupled with the compounding effect makes the TFSA one of the best saving vehicles in Canada.
Benefits:
1. With the tax savings, you can reinvest it to buy even more stocks/shares to obtain a greater dividend/capital gain in future years.
2. Flexibility: Can easily take out your money from a TFSA if you need it without any tax consequence. So if you want to buy a house in 5 years, you can empty out your TFSA.
**However, there is a limit to how much you can put into your TFSA. Use this calculator to figure out how much you are eligible to put into your TFSA.**
Summary
- Open up a TFSA account at your bank and put your money in it!
- Set up monthly contributions that go from your bank directly into your TFSA
- Since you can take out money whenever you please, use it to save for your Short/Medium Term goals (3+ years) (ex. A downpayment for a car or house)
- Reap the rewards of Tax Free Returns
Share this article with a friend who might benefit from a bit of $$ advice.
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