We at You First feel it is beneficial to periodically review the basic tax-advantaged account structures available to Canadian investors. In this segment, we’ll discuss the Tax-Free Savings Account (TFSA): who will benefit from a TFSA, what it is and is not, how it works, and we’ll finish with some frequently asked TFSA questions.
You may have read our Back to Basics article about RRSP and RESP.
If you have a question about TFSAs that was not covered off in our FAQs section, don’t hesitate to contact us.
Who Will Make Best Use of an TFSA?
Generally speaking, you will benefit from a TFSA if you need a tax-sheltered way to save money for use in the short-term (think of down payment savings in addition to your RRSP Home Buyers Plan, or an emergency / vacation fund), if your working income is the same or lower than you anticipate your retirement income to be, or if your annual savings exceeds your annual RRSP space.
What It Is and Is Not
A Tax-Free Savings Account (TFSA) is a registered account structure. This means the Canada Revenue Agency keeps an annual track of contributions and withdrawals.
A TFSA is not a basic savings account. You have many options within a TFSA structure.
Similar to an RRSP, think of a TFSA as a shopping basket and the various investment options as different types of groceries. Within your basket, you can add multiple different groceries (investments) to your basket: stocks, bonds, mutual funds, ETFs, GICs, investment savings accounts, etc. Not all investments are TFSA-eligible, but investors can choose between many different options, or a blend thereof, within their specific appetite for risk.
Dual Canadian/U.S. citizens – note that the IRS doesn’t recognize the TFSA as a tax-sheltered account structure. As such, we generally advise dual citizens against the use of a TFSA, as it adds an element of complexity and cost to U.S. tax returns.
How Does a TFSA Work?
- All adult-aged Canadian citizens and residents generate new TFSA contribution space each year.
- For 2020, $6,000 of contribution space was added for all Canadian adults.
- There is no tax savings on contributions. You contribute after-tax money.
- Like an RRSP, money invested in a TFSA grows tax-free.
- Unlike an RRSP or RRIF, money redeemed is not subject to any taxation.
- Funds redeemed are added back to your TFSA limit on January 1st of the next year.
Consider Jasmin, 36 years of age. She maximizes her TFSA space annually. She has contributed $69,500 to her TFSA and it has grown to $75,000. In late-November 2020, Jasmin wishes to redeem her entire TFSA to fund the down payment on a home purchase that closes in February of the following year.
By redeeming the $75,000 in November, the entire $75,000 (not just the original $69,500 she contributed) will re-open on January 1, plus her new TFSA space for that following year. If she waits until mid-January, a bit closer to the home closing date, that $75,000 of space will be locked until the following January 1, and she’ll only be able to maximize the newly generated space.
Frequently Asked Questions
Question: I have contributed above my lifetime TFSA limit. What are the consequences and what do I do?
Answer: Unlike with the RRSP, there is no “buffer” over-contribution amount. If you over-contribute, you will have to pay a penalty of 1% per month on any excess. This 1% per month will add up fast, so if you even think you may have over-contributed, you’re better off investigating right away.
Question: What is the current lifetime TFSA contribution maximum?
Answer: If you are the age of majority in your province of residence since 2009, have been a Canadian resident the entire time, and have never contributed to a TFSA, your 2020 contribution limit is $69,500. We can help to determine your contribution limit if one or more of these stipulations does not apply to you (for instance: turned 18 in BC in 2014; already have a TFSA and have contributed; lived in Canada for some but not all years since 2009).
Question: What happens to my TFSA space if I don’t use it? Do I lose this space?
Answer: No. Any contribution space that you do not use is carried forward indefinitely.
Question: How much tax do I pay when I take money from my TFSA?
Answer: You don’t pay any tax on redemptions, or on any other aspect of the TFSA.
Question: What about the growth in the TFSA. Surely I must have to pay some kind of tax?
Answer: No. This is truly about as straightforward as it gets. Growth is entirely tax-free. There are some exceptions to this rule but generally the exceptions apply to “professional investors”.
Question: How many TFSAs can I have?
Answer: You can have as many accounts as you want, provided your aggregate contributions do not exceed your lifetime TFSA contribution limit.
Question: How do I find my TFSA Contribution Limit?
Answer: You can get your “as of January 1st” TFSA space via the CRA website, but the CRA tabulates contributions for a given year once all financial institutions have uploaded contribution and withdrawal data. This means the CRA website can inaccurately reflect your true space in early months of a calendar year.
This information is provided for general information purposes only. It does not constitute professional advice. Please contact a professional about your specific needs before taking any action.