Tax-Free Savings Account (TFSA)
TFSAs Explained
Tax-Free Savings Accounts (TFSAs) were introduced in Canada in 2009. They allow individuals over 18 to set aside a limited sum each year completely tax-free. That means your savings and any interest earned on the savings are exempt from taxation. These financial tools enable Canadians, especially those earning lower incomes, to invest and earn income without the burden of taxation.
In this guide, we unpack the basics of TFSAs, how they work, withdrawal and contribution rules, and how to get the most out of your savings potential with a TFSA.
How Do TFSAs Work?
Every year, the Canadian government sets a TFSA contribution limit. You are allowed to contribute a set amount to your TFSA completely tax-free each year, but as soon as you exceed the yearly contribution limit, you’ll be subject to a 1% tax on the excess each month.
Any unused contribution room can be carried forward indefinitely. If you turn 18, you are eligible to contribute to a TFSA, but if you’re 22 and have made no contributions yet, you can contribute for the missed years as well. So far, the yearly contribution limits are as follows:
- 2009-2012: $5000 per year.
- 2013-2014: $5500 per year.
- 2015: $10,000
- 2016–2018: $5500 per year.
- 2019-2022: $6000 per year
- 2023: $6500
- 2024: $7000
If you use a TFSA as intended, saving becomes much easier. However, there are a few conditions to keep in mind. We’ve summarized the key details below.
Tax-Free Growth
The funds in your TFSA can grow via interest, dividends or capital gains. When you use your TFSA to invest in assets, such as stocks, bonds, mutual funds or ETFs, any growth is not subject to taxation.
However, tax-free growth does not mean tax-deductible. Any funds you contribute to a TFSA cannot be deducted from your income tax.
Flexible Withdrawals
You can withdraw your funds from a TFSA whenever you want. This gives it a significant advantage over other savings accounts. However, we recommend not withdrawing your funds unless it’s necessary. You won’t be able to re-contribute the withdrawn amount (if doing so exceeds the yearly contribution limit) until the next year.
Eligibility
All Canadian residents aged 18 and older with a valid Social Insurance Number (SIN) are eligible to open a TFSA.
Impact on Government Benefits
Withdrawals from a TFSA do not impact federal income-tested benefits or tax credits, such as the Canada Child Benefit or the Goods and Services Tax Credit.
Investment Options
TFSAs are a popular investment account. You can choose from a wide range of investment choices, such as stocks, GICs, or ETFs. The good news is that any growth from investments does not count towards your annual TFSA contribution limit.
Check out our guide on getting started with investments.
No Lifetime Contribution Limit
Unlike other investment accounts, there is no lifetime cap on how much you can contribute to a TFSA.
TFSA Contributions And Withdrawals: Tips And Pitfalls
You already know that you can withdraw your money from a TFSA whenever you want. However, when it comes to replacing the withdrawn amount, a few conditions apply:
- Wait until next year: If you withdraw $3000 from your TFSA and already contributed the maximum amount for the year, you cannot replace the $3000 until the beginning of next year. If you try to re-contribute, you exceed the limit. The excess amount is then subject to a tax penalty of 1% per month until you withdraw it again.
- Don’t over-contribute: Keep track of how much you contribute to a TFSA each year. Any excess is subject to a 1% tax.
Here’s an example to illustrate re-contribution terms:
Cedric has been diligently contributing the maximum TFSA dollar amount annually from 2013 to 2020. In 2021, he contributed $2,000 out of the $6,000 limit, leaving him with $4,000 unused contribution room. If Cedric withdraws $500 in 2022, this amount will only be added back to his contribution room in 2023. His total remaining contribution is still only $4000.
How To Maximize Your TFSA: Strategies For Growth
Who wouldn’t want to maximize their TFSA growth? Since TFSAs are a great way to save money for your future or long-term plans, the best thing to do is make the most of your annual contribution limit and the tax-free growth from investments. Below are a few tips to achieve this goal:
- Diversify your investments: One of the best ways to grow your funds is to invest in a variety of assets. Safe options such as GICs provide guaranteed returns. Others, like ETFs, stocks and bonds, provide higher returns with slightly more risk. Ideally, a combination of investments gets you the best of both worlds.
- Income-splitting: In families earning a joint income, both spouses can contribute to their own TFSA, maximizing the family’s overall tax savings.
- Retirement savings: Since withdrawals do not count as taxable income, they are a good source of funds for retirees who anticipate being in the same or higher tax bracket after retirement.
- Automate contributions: Consider setting up monthly automated deposits. This will help you capitalize on the compound interest over time.
Final Thoughts
Overall, a well-managed TFSA can be a good savings vehicle to meet your long-term financial goals. Perhaps you want to save for a down payment on a house, put together an education fund, or add to your retirement savings. With some smart investments, a TFSA allows you to save and earn money with your money, making these goals possible. Even if you don’t meet the yearly contribution limit, you can rest easy knowing that the funds in your account are not subject to taxation, and you can access your money whenever you need it. Happy Saving!
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