I thought it would be fun to get into the holiday spirit by answering a question I frequently get asked by my young married clients: should I start a TFSA?
Unfortunately, just like Halloween costumes, there’s no “one-size-fits-all” answer.
To determine whether or not a TFSA is for you, the main question that you need to answer is, “will my income tax bracket be higher now or in retirement?” If it is projected to be higher in retirement, then a TFSA will probably be an ideal retirement account for you.
To understand why this is true, I present you with a simple Trick-or-Treat analogy.
When you were a kid you probably spent a good three or four hours on Halloween night tricking it from house to house until your legs went numb, all in a quest to have enough candy to last until at least Thanksgiving. Every year, despite being completely exhausted, you would race home and dump out my treats on your bedroom floor and count them one-by-one.
Unfortunately – and you would always forget about this – the most intimidating creatures you would see that night was waiting at home: Your parents, the candy-snatchers.
Now your parents weren’t there to steal your candies for their enjoyment (Well… Maybe a candy here and there to cover the “Parents Tax”). No. They were mainly concerned about your well-being, and would sift through each and every one of your candies before you could devour them, to make sure they were safe to eat. And without fail, every year, a handful of your treats would be thrown into the trash – a necessary loss to be able to enjoy your overall gain.
And this is exactly how a TFSA works. TFSA contributions are taxed before they go into your account. The Government confiscates a portion of your contribution before you can invest and let it grow. The benefit is, these contributions and all their future earnings are never get taxed again.
Yes, you read that right: The contributions AND ALL OF THEIR FUTURE EARNINGS are never get taxed again.
It’s just like your trick-or-treating experience. Your parents confiscated your “questionable” treats, before you can touch them. All the candies that were left over were parents-approved treats that would satisfy your sweet tooth.
The sacrifice you made up front was well worth the long-term benefit! The same is true for a YFSA.
So how do you go about determining whether your income will be higher in retirement or lower? Here are a few questions/thoughts to consider:
1) What tax bracket are you in now?
a. If you’re in a 15% tax bracket, you should fund a TFSAbecause chances are this is the lowest tax bracket you will ever find yourself in. You probably fit in a 15% tax bracket if your gross income is $45,000 or less as a single filer or $90,000 or less as married filing jointly.
b. If you’re in the 20.5% tax bracket, maybe fund a TFSA. This is always the gray zone. Your tax bracket may or may not be higher in retirement. You probably fit in the 20.5% bracket if your gross income is between $45,000 and $90,000 as a single filer or between $90,000 and $180,000 as married filing jointly.
c. If you’re in the 26% tax bracket or higher, don’t fund a TFSA. You probably don’t qualify to make a direct contribution anyways. However, if you have maxed out all your tax-deferred options, it makes sense to make a contribution to a TFSA.
d. Remember, the above are generalizations. Nothing is guaranteed and can only be projected and analyzed with your particular situation.
2) Are federal income tax rates going to go up in the future?
It’s highly probable.
Just compare the trend of our marginal income tax rates to the federal debt owed per person. You start to realize that the path we are on is unsustainable. We can make as many cuts in expenditures as we want, but sooner or later, we’re going to have to raise taxes to pay for all we’ve spent and plan to spend in the future.
If future tax rates are going up, that is another compelling reason to fund a TFSA. Why take the chance on getting a higher income tax rates in the future?
3) If you are in a high income tax bracket, even though it probably makes sense to make all your retirement contributions to tax-deferred accounts, you will be eliminating all tax flexibility in retirement if you do so.
For example, if you find yourself in a year where you’d like to take a couple of trips to Europe or somewhere else exotic, you might need an extra $10,000 of spending money that year. If you are pulling from your tax-deferred retirement accounts like a RRSP, you might have to withdraw anywhere between $14,000 and $18,000, to be left with $10,000 after income taxes are withheld. That could push you into the next tax bracket, which would be a negative event.
Now if someone funded a TFSA throughout their career, despite being in a high tax bracket. When that unusually high spending year in retirement comes along, they can just withdrawal the exact amount ($10,000) from their TFSA, because it won’t be taxed. Thus, they aren’t pushed into a higher bracket and taxed an exorbitant amount.
So consider these ideas when determining whether or not a TFSA is the right retirement account for you. And remember to always take advantage of the match in your employer-provided retirement plan before you fund a TFSA. Because that’s basically free money.
Happy Halloween everyone!
My father had already traveled to a dozen countries when I was born so in a way I may have a travel gene in my DNA. I grew up in 4 different countries on three different continents but despite all of the travels with my parents, I was eager to see the rest of the world. When I was 18, I made a promise to myself that I would travel at least once a year. That same year I went to New York City, The following year, I went to Montreal. The year after that, I spent weeks in Nevada and California. Last year, I spent about two months traveling all over the world in 5 countries and over a dozen cities. I’ve kept my promise to myself, even though my income was lower than $30000 for many of these years.
Let’s face it: travel takes time, money, and planning. When one or more of those things is in short supply, many people push travel to the back burner. I don’t blame them. Especially when you’re in your twenties, things like paying down debt and building up a savings cushion should, in my opinion, absolutely come before travel.
Even though money was in short supply, and even when my debt level was higher , I’ve made travel a constant priority. Sometimes it almost seems to run contradictory to my longer term goals of saving, saving for a house, and eventually, becoming financially independent of a job. So why do I travel so much?
Well obviously I love it, It is relaxing and allow me to disconnect from my regular life and at the same time enhance it but most importantly I get to see different places and know different people with different cultures which widens my perspective. I have made friends all over the world and still keep in touch on a regular basis with many of them. You also create so many unbelievably unique and interesting memories. I have been able to enjoy all of these benefits on a smaller income because I live a frugal life which allows me to maximize my savings. Setting up a budget and clear goals that I put on my walls or where ever I can see them constantly helps me create a plan to achieve them and stay on track.
Your travel plans must be manageable. if you are on a smaller budget, you can take trips closer to home where you can drive instead of flying. Consider crashing at a family member/friend's place or using websites such as Couchsurfing or Airbnb instead of staying in a hotel. There are also many groups on meetups that offer discounted weekend escapes where you can meet local people that love to travel. Traveling is no longer just for the rich as it is cheaper and easier than ever and can definitely be done on a tiny salary.
Start saving something in an account specifically earmarked for travel. By putting As little as $20 a month aside, you can offer yourself one of hundreds of discounted flights to great destinations available everyday, a relaxing week at a nearby state park, a scenic road trip to the beach or the mountain, swap or rent an apartment on airbnb or similar website. Even if you don’t have a trip planned at the moment, small savings add up to big things. When you do find the time to take a trip, if you save diligently enough, the money will be waiting for you.
When you do go on a trip DO NOT FORGET to buy TRAVEL INSURANCE, Traveling is fun and great for your mental and physical health but it can quickly turn into a nightmare if you don't have have any protection in case of a medical emergency, missed flights, lost luggage etc.. PACK YOUR BAGS AND GO SOMEWHERE, Thank me later. :)
Society teaches us everything we know about rich people.
Rich people live in expensive homes, drive expensive cars, wear expensive watches and take expensive vacations (when they want). They eat and drink like kings and queens, and dress like Bradley Cooper and Halle Berry. They do this because their money enables them to do it. What else can you do with all that money?
The problem is, many people who live richly and actually have the means to do so are what we classify as “inheritors” of wealth, and did nothing on their own to obtain their wealth. I’m talking about people with rich parents or rich uncles. Lottery winners fit into this group, too.
In addition to these, there are some wealthy people who do in fact work very hard early on in their lives, but come into massive wealth so fast (lacking any financial know-how) that they immediately feel an obligation to start spending and keep up with the Joneses. Think pro athletes and entertainment stars.
if you haven’t noticed, the media glorifies this type of lifestyle.
Unfortunately though for us “regular Joes” of the middle class, wealth doesn’t just fall into our laps. To add to that, we often don’t have the patience or discipline it takes to build that type of wealth.
But thanks to movies, music and commercials, we still greatly desire the lifestyle that wealth affords. So instead of saving to become wealthy, we put the cart before the horse and spend all of our money just to “live richly.” And it doesn’t hurt that all this spending makes our friends think we are rich too. Sadly, spending richly tends to lead to quite the opposite.
You see, if you don’t already have millions of dollars, you can’t have your cake and eat it too. If you want to live richly by indulging in an expensive lifestyle – you can do so but at the sacrifice of never becoming rich.
Unfortunately, despite all of this spending, these luxuries we buy will start to lose their luster. And instead of realizing that true happiness can’t be “bought”, most of the time we just end up envying those that have more than we do. As a result, we work tirelessly to find a way to make more money so that we can feel better about our status again.
Now you’re thinking, “but if I could just become rich, then I CAN have my cake and eat it too, right?”
The more appropriate question is, if you aren’t fortunate enough to inherit your wealth, and you don’t have unbelievable athletic talent or a knack for entertainment, then how do you become wealthy?
It’s simple: Live well within your means. Save. Invest . (Repeat).
And over time you can amass enough wealth to afford the lifestyle you want, without dwindling down your riches. There’s nothing sexy about how you come into this wealth, it’s just old-fashioned hard work, diligence, and planning.
Don’t believe that it’s possible?
The Millionaire Next Door (which I highly recommend) written by Thomas Stanley and William Danko uncovers the secrets to how self-made millionaires amassed their fortunes.
What did their findings show?
The number one defining factor for these self-made millionaires is that they lived well below their means. According to Stanley and Danko’s surveys, the typical millionaire reported that he or she never spent more than $399 for a suit of clothing, $140 for a pair of shoes, or $235 for a watch. And most of them have never spent more than $30,000 on a car and are typically driving something other than this year’s model. Lastly, the majority of self-made millionaires don’t live in high-status neighborhoods – they truly live next door.
Doesn’t sound like the typical millionaire we’ve all come to know and love on TV, right?
By living well below their means, these self-made millionaires afforded themselves the opportunity to put their money to work. And according to the book, on average, these self-made millionaires saved and invested nearly 20 percent of their household realized income each year. That compares to the 10 to 15 percent recommendation of most financial advisors.
It takes a bit of sacrifice up front, but the payoff in the end is well worth it:
Financial Independence. Peace of mind. A lifestyle you can enjoy. Being in a position to help others.
So now the choice is yours.
Do you want to live like a millionaire or actually be one?