The Ultimate Guide to TFSAs

A tax-free savings account (TFSA) is a Canadian account and does precisely as the name suggests; it offers a tax break on your contribution income. That means thousands of dollars each year that you can put into your TFSA to grow tax free. And when you withdraw it? It is still tax free.

The contribution limit for 2024 is set at $7,000. Why? To compensate for inflation.

According to statistics, the average usage rate of a TFSA was an impressive 40.4% for Canada as a whole. The highest usage rate was in Ontario with a hefty 45% of households! These remarkable numbers only prove that TFSAs are a popular investment choice. Let’s take a look at TFSAs in Canada, from how they work to the pros and cons.

What is a tax-free savings account?

A tax-free savings account is a government-sponsored investment account that can be used for any purpose. You can invest or save up to a certain amount in a TFSA each year if you are over 18 years old, and any unused contribution room can get carried over to future years. A TFSA is a tax shelter account that allows every Canadian to save and invest tax-free.

TFSAs are pretty adaptable and can be used to save for anything, such as retirement, vacations, a car, a wedding, or anything your heart desires. Once you’ve saved up enough money, you can withdraw it without penalty and without paying taxes.  The following aren’t taxed and can be withdrawn tax-free from a TFSA in Canada:

• Contributions 
• Dividends
• Interest earned 
• Capital gains 

TFSAs are very versatile. They allow you to hold certain investments in your account. This lets you adapt your account to your specific financial plans and goals. Types of investments you can hold in your TFSA include:

• Cash 
• Stocks
• Bonds
• Mutual funds
• Exchange-traded funds (ETFs)
• Guaranteed investment certificates (GICs)

How and where to open a TFSA?

A TFSA can be opened by any Canadian 18 years old or older and has a valid social insurance number (SIN). Simply send your SIN and date of birth to a provider. They’ll likely need documentation, such as a birth certificate, to verify your identity. The entire procedure should not take more than ten minutes.

In several provinces and territories, an individual must be 19 years old to enter into a contract, including starting a TFSA. The TFSA contribution room for the year a person turns 18 gets carried over to the following year when that individual turns 19 and can enter into a contract in that territory.

Banks, credit unions, wealth management firms

TFSAs are issued by major institutions like the Big 5 banks (RBC, TD, Scotia, BMO, etc.), credit unions, and wealth management firms. You can often choose to manage your TFSA on your own or rely on their advisors. If you go to a branch, they’ll take the time to explain the rules of TFSAs and make sure this product is right for you.

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Investing by yourself in a TFSA

Robo-advisors and online brokers are a better choice for those who have good financial literacy. These providers often have no minimum investment and lower fees. That’s the best way to keep your money in your pockets. Keep a record of your annual and lifetime contribution limits to avoid exceeding them, as you want to avoid wasting any of your tax-free income on fees!

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When was the TFSA program introduced in Canada?

In 2008, Canadian Minister of Finance Jim Flaherty announced the TFSA as part of the federal budget for 2009. Persons 18 years of age or older with a valid social insurance number (SIN) could begin contributing on January 1, 2009, when the program entered into effect. 

The program’s original goal was to assist Canadians with saving for things like a new vehicle, a home renovation, a small business start-up, or a family vacation. However, since its inception, it has evolved into a tool for saving and investing.  Now, TFSAs are commonly used for longer-term financial goals such as retirement. 

How the TFSA works in Canada

The TFSA is a multi-purpose investment account. The money in your TFSA can be used whenever and however you want. It is much more flexible than other registered accounts that are committed to specific goals, such as retirement savings or post-secondary education.

As the name suggests, all forms of income earned from investments within the Tax-Free Savings Account are tax-free. This includes any interest, dividends, or capital gains. Even though the term “savings account” is included in the name, your TFSA is a powerful investment tool. 

Under the TFSA umbrella, you can open a variety of investment vehicles including mutual funds, GICs, robo-advisors, and self-directed brokerage accounts. Investing in your TFSA is the best approach to optimize its tax-advantaged potential. That’s because a TFSA often provides a higher return rate than a traditional savings account.

Contributions to your TFSA

TFSAs are as straightforward as they come. Post-tax contributions are made, and they grow tax-free. They assist you in avoiding taxation on the growth of your investments.

Each person over 18 years old has a TFSA contribution limit between $5,000 and $7,000 per year, which changes each year. The contribution room that hasn’t been used yet can be used in the future. Sign in to the CRA’s online site to check your contribution room or get a TFSA Room Statement from the CRA. With a TFSA, there is no lifetime cap, and your contribution room grows each year!

When it comes to contributing to your TFSA Canada, there are two contribution limits to keep in mind: 

• The annual contribution limit
• The lifetime contribution limit

If you over-contribute to your TFSA, you’ll have to pay a monthly fee of 1% of the amount you over-contributed until you withdraw it. The Canada Revenue Agency (CRA) keeps track of your TFSA contributions and withdrawals, and if you put too much money in your TFSA, you’ll face the over-contribution penalty. If you’re not careful, you could negate the benefits of a TFSA by over-contributing. 

Annual contribution limit

Each year, every Canadian over 18 receives the same amount of yearly TFSA contribution room.  The maximum contribution room has grown from $5,000 in 2009 to $10,000 in 2015, then it went back down and is now at $7,000. To calculate your lifetime contribution limit, you’ll need to know your yearly contribution limits since you turned 18. Also, the annual contribution limit for TFSAs will always get adjusted for inflation and rounded up to the nearest $500.

2009 – 2012: The annual TFSA contribution limit was $5,000.

2013 – 2014: The annual TFSA contribution limit was $5,500.

2015: The annual TFSA contribution limit was $10,000.

2016 – 2018: The annual TFSA contribution limit was $5,500.

2019 – 2022: The annual TFSA contribution limit was $6,000.

2023: The annual TFSA contribution limit was $6,500.

2024: The annual TFSA contribution limit is $7,000.

Lifetime contribution limit

The amount of money you can put into a TFSA is referred to as your contribution room. You have accumulated contribution room for every year since 2009 that you were 18 or older and a resident of Canada, even if you didn’t have a TFSA at the time. Log into your account on the Canada Revenue Agency (CRA) website to find out how much contribution room you have. 

To put it differently, if you turned 18 before this year and are starting your first TFSA, you can contribute more than this year’s annual contribution limit to catch up on the missed years. Similarly, if you withdraw funds from your TFSA, you will get that contribution room back in the following year. Let’s look at an example:

If you’re 25 years old, turned 18 in 2016, and you’ve never opened a TFSA Canada:

Between 2016 and 2023, you are eligible for the combined contribution room. According to the maximum contribution limit for 2016–2023, you could contribute $47,000. Because you’ve never utilized a TFSA before, you’ll be able to contribute the total amount in 2023 without incurring any penalties.

TFSAs are one of the most valuable and flexible financial solutions accessible to Canadians. And it’s completely free as long as you stick to your contribution limits. If you make an over-contribution, the CRA will tax you at 1% per month on the largest excess TFSA amount until you withdraw it.

How to withdraw from your TFSA

It’s just as straightforward to withdraw funds out of your TFSA as it is to put money into it. You don’t need to fill out any paperwork or make special arrangements to withdraw money from your TFSA.

You must, however, be aware of how your withdrawals impact your contribution limits for that year. Remember, when withdrawing funds out of your TFSA, you won’t be able to get that contribution room again until the following calendar year. Here’s an example:

You cannot replace the entire withdrawal amount within the same year. Say you contribute $6,000 for the tax year 2023. The contribution limit is $6,500, so if you withdraw $2,000 later in 2023, your available contribution room is still just $500.

If you wait to 2024, you can put back that $500 from 2023 in your TFSA, and still have a your new year’s contribution room of $7,000. You could decide to contribute $7,500 at the beginning of 2024 and still not exceed your total limit.

Withdrawing your capital gains

Because investment gains in your TFSA Canada are tax-free, they are not counted as taxable income and form part of your contribution room when you withdraw. Here’s an example:

You would have $5,250 in your TFSA account if you put $5,000 in and gained $250 in capital gains. You have the option of withdrawing the entire $5,250 tax-free. The following calendar year, you would get $5,250 added back to your contribution room.

Money withdrawn from a TFSA will not affect Canada Pension Plan payments or other income-related benefits for retirees. That means you don’t have to worry about your TFSA interfering with access to your government benefits. You can invest with the stress. 

There are several benefits to having a TFSA in Canada:

• Tax-free compounding: A TFSA’s investments compound tax-free. This allows your investment to grow faster without being slowed down by annual taxes. You could be looking at $100,000s in tax-free compounding values! If you contribute around $3,500 into your TFSA every year for 40 years, you’ll have an extra $358,963 in tax-free growth!

• You and your spouse can share a contribution room: Since TFSA contributions are made with after-tax earnings, the government won’t object if you give your spouse money to put into their TFSA. This suggests you can combine your contribution room with your spouse and make the most of their tax-free space. Unless you want to be audited, you can’t do this with an RRSP.

• Withdrawals can be made anytime: Withdrawals from a TFSA can be made at any time and are tax-free.

• There are no mandatory withdrawals: With TFSA Canada, there are no mandatory withdrawals. A TFSA can grow tax-free for the rest of your life. In comparison, after the age of 71, RRSPs have compulsory withdrawal rates.

• Regardless of income, the contribution room is the same: The contribution room for a TFSA is the same regardless of your income. This is ideal for those with a lower or moderate-income. It is conceivable for these households to tax-shelter a bigger percentage of their income. In tax-sheltered accounts, the average Canadian family may save 32% of their income. This increases for lower-income earners thanks to the TFSA.

• Government benefits will not be affected by withdrawals: Withdrawals from a TFSA are not considered income. This means that government benefits won’t get impacted. This is highly beneficial for low-income seniors who get benefits with high clawback rates, which can range from 50% to 75% of the next dollar earned.

• The contribution room will return the following year: When you withdraw funds from your TFSA, the contribution room will return on January 1 of the following year. This means a TFSA can be used to save for a wedding or a down payment in the short or medium term.

• Upon death, there Is no tax: There is no tax on death because TFSAs are tax-free. This implies you can leave your assets to your children without incurring any tax implications.

• TFSAs can be used as collateral for a loan: A TFSA’s assets can be used as collateral to secure a loan. So you can use a  TFSA to obtain a mortgage or anything similar. It’s possible you won’t be able to withdraw funds from your TFSA until the loan is paid completely.

There are also a few disadvantages of TFSAs in Canada:

• Creditors don’t offer protection: One significant disadvantage is that TFSAs are not protected from creditors. Your creditors may seize your TFSA if you are involved in a lawsuit or bankruptcy. If you utilize a TFSA to save for retirement, they may be able to take everything. In contrast,  RRSPs are creditor-protected. Comprehensive vehicle or property insurance, as well as umbrella insurance, can protect you from this risk. This is all very risky if you’re using your TFSA Canada as your primary retirement account.

• There is no reduction in income tax: TFSA contributions, unfortunately, cannot be utilized to reduce your taxable income. As a result, you won’t be able to reduce your taxable income by contributing to a TFSA. This makes an RRSP more attractive to high-income earners.

TFSA vs. RRSP: what’s the difference?

Unlike a registered retirement savings plan (RRSP), a tax-free savings account can be used to save for anything. The two main differences between  a tax-free savings account and a registered retirement account are:

• RRSP contributions get deducted from your taxable income. TFSA contributions are not tax-deductible.
• Withdrawals from a retirement plan are considered income and are taxed accordingly. Withdrawals from a TFSA are not subject to taxation.

A tax credit is not given when money is invested in a TFSA. However, you can do so with an RRSP, and when used properly, this credit can be a handy tool. If you make enough money to break into a higher tax bracket, you may contribute to an RRSP and receive an exemption, allowing you to return to a lower bracket. When it comes time to take your RRSP savings in retirement, you’ll almost certainly be in a reduced tax bracket, resulting in a lower lifetime tax bill.

Diversification is always a brilliant idea when it comes to investing. Both TFSAs and RRSPs are beneficial investment opportunities. The beauty of TFSAs and RRSPs is that you can use them both to enhance your investing journey. 

When you die, what happens to your TFSA?

If you name your spouse or common-law partner as a successor holder, they can take over your plan without it affecting their own TFSA if you die. Alternatively, you can name a beneficiary or beneficiaries to receive the cash in your plan when you pass away. 

Except for Quebec, all provinces and territories offer the beneficiary or successor holder option. Note that Quebec residents can make designations in their wills. Before making any tax or estate considerations, always consult with an attorney.