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With tax season on the horizon, everyone is scrambling to make last-minute RRSP contributions. Opening a Tax Free Savings Account (TFSAs) may not be on your radar – but it should be. If you’re a smart saver, here’s everything you need to know about a TFSA and why you should consider contributing to a TFSA pronto.
What is a TFSA?
Introduced in January 2009, a TFSA is a registered account in Canada that offers special tax benefits. Within a TFSA, you can hold any type of savings or investment account (cash, GICs, mutual funds, stocks and bonds) and any income earned is tax exempt (even when withdrawn). This means any earnings are compounded tax-free over time. A big win!
Any contributions to TFSAs are done with after-tax income, so unlike RRSPs, you don’t get a tax refund for contributions. However, a big difference is that you can withdraw money from your TFSA at any time, for any reason, without paying a dime in taxes.
As of January 1, 2019, the Canadian government raised the annual TFSA limit to $6,000, up from $5,500 last year. This means that Canadians who were at least 18 years of age in 2009 can have up to $63,500 total in a TFSA.
How the TFSA Works
Unlike RESP or RRSPs, the TFSA is an all-purpose account. Unlike other registered accounts in Canada, you can spend the money inside your TFSA whenever you want, and on whatever you want. So you can use it to stash your cash for a dream trip or for home renovations. However, since your money compounds tax-free inside your TFSA, it’s best used for retirement savings.
There is a lot of confusion about how to tap into the power of the Tax-Free Savings Account. For starters, don’t be fooled by the word “savings.” With TFSAs being heavily branded as “savings accounts,” many Canadians don’t realize that they can use it to invest! Ultimately, the TFSA can be used as a powerful investment vehicle, and you can park your investments into a variety of spaces: stocks, bonds, mutual funds, GICs, and so forth (more on this later). Anything earned from your investments within the TFSA is sheltered tax-free – a huge incentive for opening a TFSA investing account.
For some savers, there are times when opening a TFSA savings account vs. TFSA investing account might make more sense. For instance, if you plan on buying a house or another big-ticket item in the near future, a TFSA savings account might make more sense. It’s a very flexible savings tool that allows you to withdraw money at any time – completely tax-free.
Or if this better suits your situation, open a TFSA savings account with a bank that offers a high-interest rate.
How to Invest your TFSA
These days, it's easier than ever to open and contribute to a TFSA. As mentioned above, some Canadians prefer to open a TFSA savings account because it better fits their life circumstances.
But if you’re looking for more growth, opening a TFSA investing account is the best option. If you use the TFSA to invest in long-term equities, you can shelter a hefty amount of investment earnings from taxes in your TFSA. For instance, would you rather shelter the 1% gained in a high-interest savings account or the 7-8% a balanced index ETF portfolio could snag you? It’s a no-brainer.
For easy investing that follows the couch potato investment strategy, you have several options:
For investors who like a little hand-holding, open a TFSA investing account with one of Canada’s best robo advisors, such as Wealthsimple (our top choice), so you can choose a portfolio of ETFs that matches your risk profile.
It’s very straight-forward to open a TFSA investing account with a robo-advisor. First, you answer a series of questions and then the computer algorithm suggests a portfolio that best matches your financial goals and risk tolerance. Once you’ve chosen a portfolio, set up pre-authorized contributions and then let the robo advisor do all the work of looking after your portfolio – at a much lower fee than what traditional fund managers charge. Read our full Wealthsimple review to find out why we’ve rated it the best robo advisor in Canada.
Get your first $10,000 managed for free for a year when you start investing with Wealthsimple.
If you're comfortable with DIY investing, all you have to do is set up a TFSA investing account with an online brokerage, and then build your own portfolio and make trades on your own. Read our full Questrade review to find out why we’ve rated it the best online brokerage in Canada.
Get $50 in free trades when you start investing with Questrade.
TFSA Contribution Room
Again, many Canadians get tripped up by the rules around TFSA contribution room limits. If you over-contribute to your TFSA, the Canadian government will charge you a fee of 1% of the over-contribution amount per month until you withdraw it. This makes some savers anxy, but stick with us – we’ll help explain the rules so you don’t get dinged.
There are two contribution limits to be aware of: the TFSA annual contribution limit and the TFSA lifetime cumulative limit.
The TFSA annual contribution limit varies year-to-year. For example, in 2019, the maximum amount you can contribute to a TFSA saving or investing account is $6,000. In 2015, it was $10,000, and then from 2016 to 2018, it was $5,500. Any unused space in your contribution maximum can be carried forward to future years. So pay attention to the contribution amounts that the government sets for each year in order to calculate your lifetime contribution limit.
The TFSA lifetime cumulative limit is the maximum overall amount of cash that you can have stowed away in a TFSA. For instance, as of 2019, the cumulative maximum contribution is $63,500 for those who were 18 years of age in 2009. However, if you turned 18 years old in 2016 and just opened a TFSA in 2019, the maximum you can contribute is $22,500 ($5,500 in 2016, 2017, and 2017 + $6,000 in 2019).
Get it now? To make it crystal clear, we’ve broken it down with this handy chart:
|Year||TFSA annual contribution limit||TFSA lifestime cumulative limit|
Withdrawing From Your TFSA
Withdrawing from your TFSA is easy: you can withdraw money the same way you can from a high-interest savings account. There’s no paperwork or forms to fill out (hooray!).
However, there are rules about withdrawing from a TFSA, which some people may find confusing. Here’s the short story: when you make withdrawals from your TFSA, the contribution room is returned the following calendar year. You can only replace the amount of the withdrawal in the same year if you have available TFSA contribution room.
For example, if you have maxed out your TFSA contribution at $63,500, but then you withdraw $2,000 in May, you can’t just plunk $2,000 back into your account in October unless you want to pay a penalty (known as a “TFSA over-contribution”). Instead, you will get the $2,000 in contribution room added onto your contribution room the following year, so on January 1, your contribution room would include $2,000 on top of the contribution room limit for that year.
RRSP vs. TFSA
TFSAs and RRSPs are both like containers holding your cash or investments, but there are some key differences between the two. Comparing an RRSP vs. TFSA, the biggest difference is how and when you are taxed. With RRSPs, you get a tax deduction in the year you make a contribution. However, if you withdraw your funds, you must pay income tax that year. Meanwhile, you don’t get a tax deduction for TFSA contributions, but you can withdraw the funds tax-free at any time.
In an ideal world, you should contribute to both TFSAs and RRSPs to cover all your bases. If you’re a millennial, a TFSA might be a better choice so you can reap the benefits of TFSA flexibility and to keep your RRSP contribution room open until your income increases and puts you in a higher tax bracket.
|Annual contribution limit||$6,000 (as of 2019)||18% of previous year’s earned income
(up to a max.of $26,500 for 2019)
|Ages you can contribute||18 and over||Up to age 71|
|Get a tax-deduction in year of contribution?||No||Yes|
|Pay income tax in year of withdrawal?||No||Yes|
However, you shouldn’t stress too much about the RRSP or TFSA decision. Thanks to the tax structure of each, you should come out with about the same amount of money whether you choose the RRSP or TFSA. Check out our article for a more detailed look at TFSA vs. RRSP.
TFSA Contribution Room Rules
- You must be over 18 years of age.
- You can contribute up to your TFSA contribution room. As of 2019, the cumulative maximum contribution is $63,500 for those who were 18 years of age in 2009.
- A tax applies to all contributions exceeding your TFSA contribution room.
- You can withdraw money from your TFSA at any time for any reason, completely tax-free.
- Withdrawals will be added to your TFSA contribution room at the beginning of the following year.
- You can replace the amount of the withdrawal in the same year only if you have available TFSA contribution room.
- Money contributed to TFSAs is done with after-tax income so you don’t get a tax refund for contributions.
- You can hold a number of things within the TFSA. The TFSA is like a basket that you put investments into (GIC's, High-Interest Savings Accounts, stocks, bonds etc.).
- Unlike RRSPs, TFSAs do not expire – meaning there’s no requirement to withdraw the funds by a certain age.
- Any unused space in your contribution maximum can be carried forward to future years.
- The TFSA is best used for investing rather than saving. If you use the TFSA to invest in long-term equities, you can shelter a substantial amount of investment earnings in your TFSA.
You can’t go wrong with opening a TFSA savings or investing account, and if you’re a millennial, it makes sense for achieving both your short- and long-term financial goals. The main thing to remember is to choose something that suits your life situation.
If you’re saving for a big ticket item (such as a house or car) and plan to make a purchase soon, a TFSA savings account might make the most sense. This will give you the most flexibility since you can withdraw the money at any time and get immediate access to your funds.
If you’re looking for growth, low fees, and a bit of guidance, opening a TFSA with one of the best robo advisors in Canada is a great option for investing your TFSA. A robo advisor takes all the work out of investing but without the high price tag of a traditional fund manager: once you’ve picked a portfolio and set up a pre-authorized payment plan, all you have to do is “set it and forget it.” Our top pick is Wealthsimple and you can read our full Wealthsimple review to find out why it’s the “top dog” in Canada.
If you’re a savvy investor who’s comfortable with buying and trading on your own, an online brokerage is likely your best bet. The fees are rock bottom and you can design your own portfolio. Read our full Questrade review to find out why we’ve rated Questrade the best online brokerage in Canada.
The choice is yours. Now go for it!