What is TFSA?

A Tax-Free Savings Account (TFSA) is a registered tax-advantaged savings account that can help you earn money, tax-free. It was introduced in 2009 by the Government of Canada as an incentive for eligible Canadians to save.

To get you started, we break down: what it is, how it works, and how it can benefit your savings plan.

Overview

Think of a Tax-Free Savings Account as a magic wallet that shelters your investments’ earnings from taxes. Imagine you’re planting seeds in a special garden where everything that grows – whether it’s interest, profits from selling stocks, or dividends from your investments – stays yours, tax-free.

For instance, let’s say you’re saving for a down payment on a house. You could stash your savings in a TFSA and watch your money grow faster because you won’t pay taxes on the interest you earn. It’s like having a turbo boost for your savings, getting you closer to your dream home faster.

Or consider planning a dream vacation. With a TFSA, any gains you make from your investments to fund that trip remain untouched by taxes. So, the more your money grows, the more luxurious your getaway could be, all without worrying about taxes eating into your funds.

In essence, it acts like a financial genie, helping you reach your goals quicker by keeping your investment earnings tax-free, whether it’s for big life moments or those special indulgences you’ve been dreaming about.

How does it work?

In a Tax-Free Savings Account, you have the power to invest in various options like cash, stocks, bonds, and mutual funds without worrying about taxes. The best part? You can take out your contributions and any earnings interest, profits from selling investments, and dividends—whenever you need. It is completely tax-free with no need to report these withdrawals as income when filing your taxes.

Every year, the Government of Canada sets a maximum amount you can contribute to your TFSA, known as the contribution limit. This limit starts accumulating from the year you turn 18 as a Canadian resident. Unused amounts roll over, adding to your future contribution room. Your TFSA offers flexibility, letting you invest, withdraw, and build your financial future without tax concerns.

Contribution Limit

Once you start a TFSA, any money you add and the earnings from eligible investments can grow tax-free—unlike a regular savings account that gets taxed.

Your TFSA has a limit on how much you can put in, called your contribution room. This limit grows every year after you turn 18 and become a Canadian resident, even if you don’t file taxes or haven’t opened a TFSA.

So, if you opened a new TFSA in 2023 and have previously never contributed to it, you would have a total contribution room of $88,000 if you were 18 years or older in 2009 and were a resident of Canada from the year 2009. Your contribution room includes this year’s limit, any leftover room from past years, and the amount you withdrew from your TFSA in the previous year. Remember, whatever you put into your TFSA during the year, including what you put back after withdrawing, counts towards this limit.

The TFSA annual contribution room for 2023 is $6,500. Additional information can be found on the CRA website here.

Eligibility for TFSA

TFSAs are available to every Canadian resident, who is 18 years of age or older with a valid Social Insurance Number (SIN).

Non-resident eligibility

If you open a TFSA and later become a non-resident for tax purposes in Canada, you can maintain your TFSA without being taxed on the earnings or withdrawals. However, if you contribute while you are a non-resident, except for certain exceptions, you will be subject to a 1% tax for each month the contribution remains in the account. You may also be liable for other taxes. Additionally, other taxes could be applicable. It’s important to note that the contribution room won’t increase for the years you’re a non-resident for the entire year.

Pros and Cons

Benefits of Opening a TFSA:

There are many benefits of using a TFSA to save:

• Added flexibility: A TFSA is a savings solution that offers you the flexibility to save for a multitude of short-term and long-term goals. It can help you reach your saving goals, and you can withdraw your money when you need it.
• Tax-free growth: You pay no tax on any investment income you may earn in your TFSA and you can hold a variety of qualified investments, including cash, stocks, guaranteed investment certificates, and mutual funds. The higher the return potential on your investments, the faster your savings may grow, tax-free.
• Retirement planning: It can complement your personal RRSP by providing additional tax-advantaged savings when you have no more RRSP contribution room or you are over age 71 and not allowed to hold an RRSP anymore. Contributing to a TFSA makes any income earned in the account tax-free, even when withdrawn.
• Making Withdrawals: You can withdraw funds from the TFSA without paying tax. This can make it a great tool to save for big-ticket items. When you’re ready to use your funds, you can withdraw without paying tax. This gives you more money for the things you care about.
  

Drawbacks:

• No Barrier To Withdrawals: Although this is a benefit I believe it is also a HUGE drawback of TFSAs. Retirement savings inside a TFSA are more likely to be “raided” because TFSA withdrawals can be made at any time and without any withholding tax.
• No Income-Tax Reduction: Unfortunately, TFSA contributions can’t be used to lower your taxable income. This means there is no way to decrease your income tax when contributing to a TFSA. For high-income earners, this makes an RRSP more appealing.
• No Protection From Creditors: Another big drawback is that TFSAs aren’t protected from creditors. If you’re involved in a lawsuit or bankruptcy your TFSA can be confiscated by your creditors. If you use a TFSA for your retirement savings they could unfortunately take it all.
  

What are the TFSA investment options?

You can hold a variety of qualified investments in your TFSA – with common investment types being:

• Cash
• Mutual funds
• GICs
• Stocks
• Bonds

Each investment type can differ in its advantages and disadvantages based on your savings goals. Consulting with a Professional can help you assess which investment option may be best for you, given the level of risk you’re willing to take.

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FAQs

How do I calculate my TFSA contribution room?

If you’ve contributed to your TFSA in the current year, that amount won’t be reflected in your total contribution room. But if you haven’t, you can log into CRA My Account to check your current contribution room.
You can calculate your contribution room by summing up:
-The current year’s contribution limit
-Unused contribution room from previous years
-The withdrawals from your account in the previous year
For instance, if in 2022 you added $4,000 to your TFSA with a $6,000 limit, then withdrew $1,000, in 2023 your room will be $6,500 plus the $3,000 from last year. Withdrawals add back to your room the following year, allowing you to contribute again.

When does the TFSA contribution room reset?

Each year, your annual contribution room is reset on January 1.

What are the rules for re-contribution to TFSA?

If you’ve withdrawn TFSA contributions and aim to replace them in the same year, ensure you have remaining contribution room. Over-contributing leads to penalties—1% tax per month based on the excess amount. For instance, if you’ve hit your limit and contribute again, you might face penalties if it exceeds.

How and when can I withdraw money from my TFSA?

You can withdraw funds any time you want and you don’t have to reach a certain age before you withdraw your money. Withdrawals made from your TFSA will be added back to your TSFA contribution room the following year. Your financial institution can help you make withdrawals from your TFSA.

What can I spend the money on?

Anything you want. You could wait until you retire and use it to supplement retirement income you may have from pensions, RRSPs, or other sources, you can also use it for short-term savings goals like a new car or a vacation, or for needs that arise suddenly like repairs to your home.