If you’re lucky enough to have scored a tax refund, then let me be the first to congratulate you for coming to GetSmarterAboutMoney.ca and reading this article. You could just as easily have taken the money straight to the mall to pick up a great new pair of shoes or a flat-screen TV (umm…been there, done that).
So the fact that you’re thinking of socking it away is good news.
There are lots of things you could do with that tax return – but putting it in a tax-free savings account (TFSA) is a good way to make the most of it. Just as a refresher, a TFSA is a registered savings account that lets you invest your money tax free and withdraw it when you need it. Plus you can contribute up to $5,500 annually. The flexibility and the fact that you don’t pay tax on any gains are two things that make TFSAs one of my favourite ways to save.
The question is, does it make sense to put your tax return into one? My answer: yes, mostly. Here’s when it makes the most sense:
If you’re earning a lower income or you’re receiving money from government programs – Registered retirement savings plans (RRSPs) make sense for people earning a higher income (they get a tax credit for money they invest now, and pay tax on it when they take it out in retirement, when they’re potentially earning less). A TFSA, on the other hand, is a fantastic savings option for lower income earners who won’t benefit from the tax deferral, because their income won’t necessarily decrease in retirement. Money saved in a TFSA can also be taken out without affecting your government retirement benefits.
If you have room – Remember: you can put in up to $5,500 a year. Put in too much, and you could get hit with an unexpected tax bill. You can check to see whether you have room here.
If you’ve maxed out your RRSP – If you don’t have any room in your RRSP, a TFSA is a good alternative for putting extra cash aside.
If you plan to retire with a full pension – If your employer provides a defined benefit pension plan where your retirement income is guaranteed, then a TFSA is a great savings option since money is withdrawn when you need it without any impact on your income (and tax bracket).
If you’re saving for something – It’s easy to take money out of a TFSA, which means that many Canadians are using them for their emergency funds or short-term savings goals.
If you’re retired – If you’re saving and investing in retirement, a TFSA is a good option to invest money. Money earned and withdrawn won’t impact your income – and won’t bump you into a higher tax bracket that might affect your government retirement benefits.
There’s one last factor to consider: your debts. Do you have any? Even if one or more of the scenarios I described above sounds like your situation, if you have debt, paying it off with your tax return might be the wisest move of all. The Pay down debt or invest calculator can help you determine what’s smarter in the long run.