There’s a pretty wide variety of savings and investing tools in Canada. But the introduction of the Tax-Free Savings Account (TFSA) in 2009 was a bit of a gamechanger, introducing a whole new way for Canadians to maximize the money they set aside while paying less tax.
Table of contents
- What is a TFSA?
- How much money can I put in my TFSA?
- What are the TFSA withdrawal rules?
- Is the TFSA a good investment?
- TFSA vs. RRSP
- What are the best investments for the TFSA?
- Does a TFSA count as collateral for a loan?
- What happens to a TFSA if the account holder dies?
- What happens to a TFSA if joint holders of an account divorce?
- Common TFSA mistakes to avoid
What is a TFSA?
A bit of a misnomer (more on that below), TFSAs is a registered savings plan that lets you grow your money. It can be a great option for both short- and long-term goals.
Essentially, the Canadian government’s intended purpose when creating the TFSA, was to encourage savings with the added tax-free incentive.
Anyone over 18 with a valid social insurance number can open a TFSA, and make regular contributions. Your money grows, and when you want to withdraw it, you’ll do so tax-free.
How does a TFSA work?
A TFSA theoretically works like any savings account, in that you set aside any amount of money you want (up to a government-set maximum). You can withdraw these funds at any time, without a tax penalty. While in the account, your money will accrue interest. Given the account’s accessibility and flexibility, it can be a great place for your emergency fund.
Now, for the misnomer part.
While it’s called a savings account — and for some people, it’s just that — almost any investment an RRSP can hold can go into a TFSA. Bonds, stocks, mutual funds, exchange-traded funds (ETFs), GICs, options, and more. A common metaphor is to think of a TFSA as a basket or bucket. In it, you can hold qualifying investments that can generate interest, capital gains, and dividends. These are all, as a result of being in the account, tax-free.
Ultimately, TFSAs are shelters that are similar to an RRSP without the contribution window — although with contribution limits!
How to open a TFSA
If you’re 18 or over, visit your financial institution, credit union, or insurance company offering TFSAs to set up an account. You can also typically open a TFSA through an online brokerage or robo-advisor like Questrade or Wealthsimple. You’ll need to provide your social insurance number and date of birth, and quite possibly supporting documents as proof.
Can you have more than one TFSA?
You may have multiple accounts, but your contributions to them cannot combine to exceed the yearly maximum.
How much money can I put in my TFSA?
To reiterate, TFSAs are great savings and investing tools with very few limitations. However, there is one significant caveat — how much money you can put into the account in any given year.
In a perfect world, you’d pack that account with as much money as possible to reap the greatest benefit of the tax savings on the interest and investment income. The annual maximums have varied from $5,000 per annum, all the way up to $10,000, so it’s a good idea to double-check your contribution limit with a TFSA calculator.
Remember: unused TFSA contributions carry forward each year. Never invest in a TFSA before 2022? You can make up for the lost time by contributing your maximum, up to $81,500.
What is the TFSA contribution limit for 2021?
The TFSA limit for 2022 is staying at the same level as it has been since 2019 — $6,000.
What is the TFSA limit by year?
With the exception of 2015, when the maximum contribution was spiked to $10,000, contribution limits haven’t changed dramatically, year-over-year. Here’s a look at the TFSA contribution limits in the past decade:
What is the lifetime limit for TFSA contributions?
The yearly limits are just that — yearly limits. You can contribute up to that maximum year-over-year, and enjoy all of the benefits of your interest, dividends, and capital gains being protected from taxes. The total amount of contributions you can theoretically have made to your account is $81,500 — assuming you were over 18 in 2009 and have contributed the max every year.
That said, since there will (probably) always be a ceiling on TFSA contributions, there will always be a limit for as long as you have a TFSA open.
What happens if you go over the maximum allowable contribution?
If you contribute past your allowance, you’ll be penalized. If you over-contribute to your TFSA, the Canada Revenue Agency (CRA) will charge you one percent, per month on the excess contribution until you remove the funds from the account. So, instead of making money off your contribution, you’ll be losing it.
What are the TFSA withdrawal rules?
The withdrawal rules are simple. There is no tax impact when you withdraw money from the account. It can take 24 to 48 hours to make it into your bank account, but it’s otherwise no different than withdrawing money from any other savings account.
Any amount of money you withdraw is added on to what you are allowed to contribute the next year. For example, let’s say that next year the limit will also be $6,000. If you invested $6,000 this year, but then took out $500, next year you will be able to contribute $6,500.
Is the TFSA a good investment?
TFSAs are quite widely praised for their flexibility and investment/savings potential.
Financial writer Jonathan Chevreau argued, as we alluded to above, that TFSA is a misnomer, saying they should instead be called TFIAs, or tax-free investing accounts. He also outlined why they can even stack up, for many investors, as a better tool than an RRSP for retirement savings, primarily because they have a longer horizon:
“An 18-year-old in 2022 has a good 47 years until the traditional age of retirement at 65. Also keep in mind that unlike RRSPs, they can keep contributing to TFSAs well into their 90s or 100s, if they live that long. I knew one lady who contributed to TFSA past the age of 100!“
TFSA vs. other savings accounts
As we explained, TFSAs are not just savings accounts. Typical savings accounts let your money sit and accumulate interest (typically around 0.75% to 2.35%) until you’re ready to withdraw it. Money placed in a TFSA can be invested in so many different ways. As a result, the money you invest can grow at a faster rate.
If you’ll need access to your money relatively soon, a standard savings account might be the option that makes the most sense. Leaving your TFSA to fully maximize your money is ultimately the best tactic.
TFSA vs. RRSP
That really depends on your financial goals for your investments. But, in general, there are some key differences between the two registered accounts.
Accessibility of funds
A TFSA is a great choice if you want to keep your money accessible. It will allow you to withdraw money at any time, so if you decide to tap into it, you won’t be hit with a tax charge. Funds you contribute are not tax-deductible.
An RRSP, on the other hand, is an investment program specifically meant for retirement. Any contributions to an RRSP are tax-deductible, but withdrawals are subject to taxation. Contributions are intended for long-term investment and will be penalized when they are withdrawn early.
Long-term contribution opportunities
You can only contribute to your RRSP up until the last day of December of the year you turn 71. After that point, the account is converted to a Registered Retirement Income Fund (RRIF), which gives you a steady income in retirement. A TFSA has no such restrictions. If you choose to work into your later years or come into money after the age of 71, you will not be able to put it into your RRSP.
Type of funds that can be contributed
The amount you are able to contribute to an RRSP is directly linked to the income you reported in the previous tax year. TFSAs are more flexible. The allowance you invest is based solely on the government-stipulated yearly allowable contribution.
So where is your money best invested? It depends on what you plan to use it.
A TFSA certainly sounds more flexible, and it is. But with that flexibility can come smaller returns. In order to know which is the right option for you, you need to be very clear on what your personal short and long-term financial goals are.
For what it’s worth, you don’t even really have to choose one or the other. TFSAs and RRSPs can both be a part of a financial plan. RRSPs are geared toward saving for retirement, i.e. a long-term goal. On the flip side, you can turn to a TFSA for goals that are more short-term, like a downpayment or home renovations, buying a car, or as an emergency fund.
If you can comfortably maximize contributions to both, go for it.
The broad rule of thumb? If you earn less than $50,000, save for retirement through a TFSA as opposed to an RRSP. RRSP contributions are tax-deductible and help reduce your tax owing. If you make less than $50k, you probably won’t owe much tax after applying basic tax credits. Essentially, the deduction isn’t as valuable.
What are the best investments for the TFSA?
Since most will be using a TFSA for retirement savings or some other larger goal, it is advisable to avoid higher-risk stocks. Instead, invest in lower-risk investments that will balance your account between growth and stability.
ETFs are one of the more reliable investment tools for a TFSA. Since they reflect established companies spread out across market sectors, they are a solid diversified option that’s great for new investors.
Does a TFSA count as collateral for a loan?
In short, yes! TFSA contributions are classified as assets. Therefore, if you are looking to secure a loan, make sure you mention the balance of your TFSA account(s) as a part of your overall net assets.
What happens to a TFSA if the account holder dies?
If you or a loved one passes away with an active TFSA, there are two scenarios that will dictate how the money is distributed.
When you set up your account, you can indicate either a beneficiary, successor holder, or both. Anyone can be named a beneficiary, though only a spouse or common-law partner can be designated a successor holder.
If a beneficiary is named, they receive all of the funds within the TFSA, tax-free. The account is then closed. If the beneficiary has contribution room in their own TFSA, they can move the money there, so it can continue to be sheltered. Otherwise, the funds could be taxed.
A successor holder, however, would get both the account and the funds.
What happens to a TFSA if joint holders of an account divorce?
A TFSA is divided between account holders upon the dissolution of a marriage. In order to complete the transfer, the account holders need to submit a form called a Transfer From a Tax-Free Savings Account (TFSA) to another TFSA on Breakdown of Marriage or Common-Law Partnership. Once the form is completed and submitted to the financial institution, the funds will be divided evenly among the two account holders.
Common TFSA mistakes to avoid
A TFSA is an incredible tool for maximizing the money you’re setting aside, but there are some common mistakes to avoid.
If funds go in and out like a typical savings account, they’re not going to be earning interest. It’s best to treat TFSAs as a long-term savings tool to grow your funds, investing where you can get higher returns. Otherwise, you might as well just use your chequing or savings accounts. The only way to reap the benefits is to keep funds in the account.
There is such a thing as ‘too much’
If you’re not following your contributions closely, you could end up overcontributing (which will cost you penalties). Having an advisor help you manage contributions, can help keep this from happening, but you should keep track of your investments too, to make sure they’re earning and not costing.
Transferring to a different institution
If you’re going to transfer a TFSA to another financial institution, make sure you double-check your allowance and ensure you’re not over the limit. When you set up a TFSA at one institution your contribution for that year is recorded. Closing one account and opening a new account elsewhere could count as a second, separate contribution rather than replacing the old account.
To transfer your TFSA mid-year, transfer the funds, rather than reinvest the same funds elsewhere.
You might have longer-term goals, but just don’t want to tie up your money in savings that are inaccessible (as with an RRSP). To help decide which investment option makes the most sense for you, it’s best to meet with an advisor. They can help analyze your goals and risk tolerance to help you pick the right investments.