tax free savings account (TFSA)
Canada introduced a popular registered investment vehicle called a Tax-Free Savings Account (TFSA) in 2009. Individuals can earn tax-free investment income with a TFSA. The money you contribute to your TFSA has already been taxed, and you do not have to pay taxes on any investment income, including capital gains, dividends, and interest, that you earn within the account. Unlike a Registered Retirement Savings Plan (RRSP), contributions to a TFSA are not tax-deductible.
TFSAs work similarly to other investment accounts. You can hold a variety of investments within a TFSA, such as stocks, bonds, mutual funds, exchange-traded funds (ETFs), and even cash. Your TFSA investments will grow tax-free, and you can withdraw your funds at any time without any tax implications.
The Canadian government sets the contribution limit for TFSAs and indexes it to inflation. The current (2024) contribution limit is $7,000, which means that you can contribute up to $7,000 to your TFSA annually without any tax consequences. The unused contribution room carries forward indefinitely if you do not contribute up to the maximum amount in a given year. However, you should note that over-contributing to your TFSA can result in penalties. You will have to pay a penalty of 1% per month on the excess amount until you withdraw it if you contribute more than your available contribution room.
Your contribution room in 2024 can be as high as:
TFSA Contribution Room Over The Years
| Year | Annual TFSA Limit | Total Contribution Room |
|---|---|---|
| 2009 | $5,000 | $5,000 |
| 2010 | $5,000 | $10,000 |
| 2011 | $5,000 | $15,000 |
| 2012 | $5,000 | $20,000 |
| 2013 | $5,500 | $25,500 |
| 2014 | $5,500 | $31,000 |
| 2015 | $10,000 | $41,000 |
| 2016 | $5,500 | $46,500 |
| 2017 | $5,500 | $52,000 |
| 2018 | $5,500 | $57,500 |
| 2019 | $6,000 | $63,500 |
| 2020 | $6,000 | $69,500 |
| 2021 | $6,000 | $75,500 |
| 2022 | $6,000 | $81,500 |
| 2023 | $6,500 | $88,000 |
| 2024 | $7,000 | $95,000 |
Why invest in a TFSA?
There are several reasons why investing in a TFSA can be a smart financial move:
- Tax-free investment income: The primary benefit of a TFSA is that any investment income earned within the account is tax-free. This can significantly boost your investment returns over time, as you are not paying taxes on the earnings within your account.
- Ideal for new immigrants: Unlike RRSP, new immigrants do not have to wait for a year to start contributing to TFSA account. Even if the immigrated to Canada mid-year, they can take advantage of the full contribution room for that year.
- Flexibility: Unlike an RRSP, there are no restrictions on when you can withdraw money from your TFSA. You can withdraw your funds at any time without incurring any tax consequences. This makes TFSAs an ideal investment option if you need access to your money in the short term.
- Re-contribution room: The re-contribution room is a great reason why you should open a TFSA. This re-contribution room makes sure that you are allowed to keep your cumulative contribution amount always. If you are to withdraw money from your TFSA, that money can be deposited again if you have an available contribution room. If you do not have contribution room for the year since your TFSA is already maxed out, then you can simply put the money in the TFSA next year once the contribution amount is increased.
- Example:
Say your total contribution room by 2023 was $6,500 and you have already deposited $6,500 in your TFSA account(s) by Mar 2023 and hence there is no more contribution room left. Now in May 2023, you needed $3500 and you withdrew from your TFSA account. In June 2023 you now have $4500 surplus and you want to deposit this back into your TFSA. Since you did not have any contribution room left, you cannot re-deposit any money into your TFSA until the next year i.e. 1st Jan 2024. The contribution limit for 2024 is $7,000), then on 1st Jan 2024, you can deposit a total of $10,500 ($7,000 from the 2024 contribution limit + $3,500 re-contribution room of 2023).
- Example:
- No age limit: There is no age limit for contributing to a TFSA. You can continue to contribute to your TFSA as long as you are a Canadian resident and have available contribution room.
- Estate planning: TFSAs can also be a useful tool for estate planning. Any funds held within your TFSA at the time of your death can be transferred tax-free to your spouse or common-law partner’s TFSA. If you do not have a spouse or common-law partner, the funds will be transferred to your designated beneficiary tax-free. All of the transferred funds from the account will not affect the beneficiary’s contribution limit either.
- Saving for specific goals: TFSAs are an excellent way to save for specific goals, such as a down payment on a house or a child’s education. Because you can withdraw your funds at any time without penalty, TFSAs can be a flexible way to save for short-term goals.
- Variety of investment choices: A TFSA can hold a wide range of investments, including stocks, bonds, mutual funds, ETFs, and cash. It is essential to choose investments that match your investment objectives, risk tolerance, and time horizon.
Who is eligible to contribute to a TFSA?
To be eligible to contribute to a TFSA, you must be a Canadian resident and have a valid Social Insurance Number (SIN). If you are a non-resident of Canada, you cannot open a TFSA.
Can you have more than one TFSA account?
Yes, you can have multiple TFSA accounts, but the total contributions across all accounts cannot exceed your available contribution room for the year. Having multiple TFSA accounts can provide added flexibility to manage your investments, but it can also increase your administrative work and fees.
What are the disadvantages of a TFSA?
- While TFSAs offer many advantages, there are also some disadvantages to consider. For example, TFSA contributions are not tax-deductible, so you do not receive an immediate tax benefit for contributing to a TFSA. Additionally, some investments, such as foreign withholding taxes on dividends, may still be subject to taxes within a TFSA.
- Another potential disadvantage of a TFSA is the temptation to withdraw funds before reaching your investment goals. Since TFSAs offer more flexibility than other registered accounts, it can be tempting to use the funds for short-term expenses, reducing the potential for long-term investment growth.
How to open a Tax-Free Savings Account (TFSA)
The Tax-Free Savings Account (TFSA) can be opened at any financial institution or a bank. As simple as it is, you should know what to do with your TFSA, some folks want to just use it to save their cash and earn the basic low interest rate. Others, would want the TFSA to be used to drive some investments for extra income! That is why it is essential that you contact a financial expert to help you build the right kind of TFSA for you and look into your different options.