Unlike the RRSP, the Tax-Free Savings Account (TFSA) hasn’t been around for ages. But it has been around long enough for Canadians to get the hang of it. Unfortunately, many Canadians still don’t understand or realize how powerful the TFSA can be in helping them build their wealth. But the number is steadily growing, and in 2019, there were more TFSA holders than RRSP holders in the country for the first time.
The problem is that just having a TFSA account doesn’t mean that people are using it the right way. Many Canadians aren’t aware of the technicalities that surround the TFSA. This means that they can’t draw out the account’s full potential, or they might get penalized for using it wrong.
The two stats should help you understand the scope of the problem.
The contribution limit
Many Canadians (about one-third) fail to realize that there is a contribution limit. And while the data on it isn’t clear, some people might make the mistake of confusing the contribution limit that has in an RRSP with what they get for a TFSA. Another fact that concerns this issue is that 40% of people don’t know that they can be penalized for over-contribution.
While it’s hard to figure out why so many Canadians are unaware of the basics of the TFSA, it’s easy to understand why people would be tempted to over-contribute. All growth in a TFSA is tax-free, and you can withdraw funds out whenever you want. If someone comes across a very lucrative investment that might double their money in a few years, they may prefer putting it in a TFSA instead of an RRSP to marinate for two or three decades.
And to maximize the benefit, they would want to invest a hefty amount, thus over-contributing and getting penalized.
Not contributing enough
This stat points toward a more widespread problem, and it’s that not everyone is maximizing their TFSAs. The average contribution last year was $5,332. And while it’s a significant step up from 2018 (when it was around $4,800), there is a lot of room for improvement. The usual yearly contribution limit of $6,000 translates into a neat $500 a month.
This is an amount that most families living on or over the average income can come up with. Even families with lower than average income can try and come up with this amount by exercising financial discipline and proper budgeting. It would be hard, but it can help them out a lot in the long run.
The best way to put that $500 saving to use is by investing it. But it would be risky to invest it all in one stock. But even if they can invest $100 every month in a safe stock like Fortis (TSX:FTS)(NYSE:FTS), they can end up with a $67,000 nest egg in two decades if the company keeps up its 10-year compound annual growth rate (dividend-adjusted) of 9.33%.
Fortis is just one example of decent, safe stock. There are many others, but it’s a stock that even people who don’t actively invest can understand. As a utility stock, its revenues are relatively safe even during market downturns. It has a very dependable income source (utility consumers), and the company has a stellar dividend history.
A stock like Fortis in your fully stocked TFSA can be a powerful tool – and not only for your retirement. Since you can withdraw tax-free income from your TFSA whenever you want, it can be a great place to build up your emergency reserves and nest eggs. But it’s important to understand what a TFSA can and can’t hold, and the fact that it is for long-term investments and not short-term trading.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.
Fool contributor Adam Othman has no position in any of the stocks mentioned. The Motley Fool recommends FORTIS INC.