In 2009, the federal government introduced Tax-Free Savings Accounts (TFSAs). This account quickly became popular with investors since it was another savings vehicle that allowed people to tax-shelter their money. However, the name is misleading, and many people still don’t understand how TFSA limits and contribution rules work. Here’s everything you need to know about TFSAs.
A TFSA is a registered plan that allows people 18 or older with a valid Social Insurance Number (SIN) to save a certain sum of money each year without paying taxes on the earnings. You can use your TFSA for more than just savings despite the name.
You can invest in mutual funds, stocks, bonds, guaranteed investment certificates, and more. Although you don’t get a tax break when you contribute, you won’t pay any taxes on capital gains. All of your savings and investments are entirely tax-free when inside a TFSA. Your TFSA is similar to other registered plans, such as a Registered Retirement Savings Plan (RRSP). You can deposit money into the account, purchase investment and savings products, and hopefully watch your balance grow.
The main difference with TFSAs is that you don’t pay any capital gains to the Canada Revenue Agency (CRA) when you withdraw your money. What you do with your TFSA account is up to you. Some people use it for short-term savings, such as an emergency fund or a down payment. Others use it for retirement savings, while some people purchase high-risk stocks in their TFSAs, hoping to strike it rich.
TFSA contributions and how they work
TFSA contributions can be tricky as various factors depending on your situation. First off, there’s a yearly contribution limit. For 2022, the TFSA contribution limit is $6,000. Your contribution room also carries forward from previous years. That means that if you were eligible to contribute in previous years but didn’t have the cash, that unused quota gets added to the current year’s allocation.
As of 2022, the total contribution limit is $81,500 if you were 18 years of age on or before 2009.
For reference, here’s how much TFSA contribution room there has been in each year since the account’s debut:
- 2009: $5,000
- 2010: $5,000
- 2011: $5,000
- 2012: $5,000
- 2013: $5,500
- 2014: $5,500
- 2015: $10,000
- 2016: $5,500
- 2017: $5,500
- 2018: $5,500
- 2019: $6,000
- 2020: $6,000
- 2021: $6,000
- 2022: $6,000
As of 2022, that’s a total contribution limit of $81,500. However, suppose you’ve deposited money in previous years or made withdrawals. In that case, you’ll need to factor in those amounts to calculate how much you can deposit into a TFSA in the current year. To find out your actual contribution room for the year, you can use the following formula:
Current year contribution limit + unused contribution room from previous years + withdrawals made in previous years = Current available TFSA room
You can also check your CRA MyAccount for your TFSA room. However, since financial institutions typically only report your contributions once a year, the number displayed in your CRA MyAccount may not be accurate. It’s a good idea to keep an independent record of your deposits so that you know exactly how much room you have, as you’ll pay a penalty of 1% for each month that over contributions stay in your account.
Withdraw money from a TFSA account
Withdrawing money from your TFSA is easy, and you can do it at any time if you use your TFSA to hold cash, such as in a high-interest savings account. However, some investment products may have restrictions, such as term deposits with a maturity date. Also, keep in mind that withdrawals only apply when you take money out of your account. For example, if you decide to sell a bunch of stock in your TFSA so you can purchase a different stock within your TFSA, no withdrawal has occurred.
What’s excellent about TFSA withdrawals is that the amount is added back to your contribution room on January 1 of the following year. For example, say you had maxed out your TFSA in August 2021 and then withdrew $10,000 in November. On January 2, 2022, you’d be able to contribute $16,000: your $6,000 contribution for 2022 and $10,000 to make up for your withdrawal. You can’t however withdraw money and then add it back in the same calendar year (unless you have available contribution room).
To continue our example above, let’s say you withdrew $10,000 from your maxed-out TFSA in November 2021. You couldn’t re-contribute the money in December 2022; instead, you’d have to wait for the following year to begin.
Also, note that transferring your TFSA from one financial institution to another doesn’t count as a withdrawal. You need to ensure it’s done correctly by asking your new financial institution to initiate the transfer. Your old bank may charge a fee to transfer your account, but some financial institutions will cover the cost for you.
How to open a TFSA account
Opening a TFSA is easy, as most financial institutions, insurance companies, and investment firms offer TFSA accounts. A self-directed TFSA, which allows you to be in total control of the investments you choose, is also an option. To open a TFSA you need to meet some basic criteria:
- You must be 18 years or older, or the age of majority in your province.
- You must be a resident of Canada.
- You must have a valid SIN.
The age rule is based on your actual birthday, not the calendar year. Let’s say you’re turning 18 on November 1, 2022. You’d be able to open a TFSA and contribute the total amount for the year ($6,000) on that date. That said, in Newfoundland and Labrador, New Brunswick, Nova Scotia, British Columbia, Northwest Territories, Yukon, and Nunavut, the age of majority is 19. That means you may be able to open a TFSA until you turn 19. Fortunately, the contribution room for the year you turned 18 will carry over.
You’re allowed to have more than one TFSA, but your total contribution room doesn’t change. It’s shared between all of your accounts. Regardless of your goals, a TFSA is just one account to help you reach them. Understanding the rules is vital as you’ll be able to use your TFSA to your advantage while avoiding any penalties.
Pros of TFSAs
- Tax-free earnings. All of your capital gains are tax-free. When it’s time to make a withdrawal, you don’t have to pay the CRA.
- Equal contribution room. Regardless of your income, everyone gets the same TFSA contribution room.
- Easy withdrawals. You can make withdrawals anytime and get the contribution room back the following year.
- Flexible. You can purchase different savings and investment products, including bonds, stocks, and exchange-traded funds (ETFs), to keep in your TFSA.
Cons of TFSAs
- No immediate tax break. Unlike when you make RRSP contributions, you don’t get a tax break when contributing to your TFSA.
- Tracking contribution room is essential. Since the CRA doesn’t track your contributions and withdrawals in real-time, you need to follow things independently. Disorganization could lead to overcontributions and penalties.
- Complicated rules. Many people don’t understand the TFSA rules, which prevents them from using the account to the maximum potential.
- Day trading isn’t allowed. The CRA considers day trading business income, so it’s not allowed in your TFSA.