What is Tax-Free Savings Account (TFSA)

Tax-Free Saving Account (TFSA) is a tax planning tool allowing tax-free savings. However, it is critical to understand the rules around TFSA to take advantage of it. Unlike RRSP, TFSA is a more flexible savings account that you can use for various saving goals. (first home, rainy days, a vacation, or a new car, etc.).

Whether you’re saving for your first home, rainy days, a vacation, or a new car, a Tax-Free Savings Account (TFSA), can help you save and grow. TFSA is a registered investment that allows tax-free growth (tax-sheltered), unlike a non-registered savings account!

How do TFSAs work?

Inside a TFSA account, you can hold certain investments like cash, stocks, bonds, and mutual funds. Also, you can withdraw contributions as well as the interest, capital gains, and dividends earned in the account at any time without paying taxes. You don’t even report the withdrawals as income when you file your taxes.

How much money can I contribute to TFSA?

Each year, the Government of Canada determines the maximum amount a holder of a TFSA can contribute, called “the contribution” limit. The annual TFSA contribution limits per year since TFSAs were introduced in 2009 are listed below.

• The annual contribution limit for the years 2009-2012 was $5,000.
• The annual contribution limit for the years 2013-2014 was $5,500.
• The annual contribution limit for the year 2015 was $10,000.
• The annual contribution limit for the years 2016-2018 was $5,500.
• The annual contribution limit for the years 2019-2022 was $6,000.

If you don’t contribute up to the contribution limit for a given year, the unused amount is carried forward and is added to your contribution room for future years.

Who is eligible for a TFSA?

TFSAs are available to every Canadian resident who is 18 years of age or older. Your contribution room accumulates each year in which you are 18 years of age or older and a resident of Canada, even if you don’t file an income tax return or open a TFSA.

Eligibility for non-residents of Canada

If you become a non-resident of Canada for tax purposes after opening a TFSA, you can keep your TFSA and will not be taxed in Canada on any earnings in the account or on withdrawals from it. However, you will not be allowed to contribute additional funds and no contribution room will accrue for the years in which you are a non-resident.

What benefits can I enjoy after opening a TFSA?

TFSA offers a variety of benefits, including the following when you choose it to save:

More flexibility

TFSA savings solution offers you the freedom and flexibility to save for loads of short-term and long-term saving goals. It empowers you to reach your savings goal and lets you withdraw money any time you need it. 

Tax-free growth

You are free from paying any tax on any income that you earn in your TFSA. Moreover, it allows you to hold a range of investments like stocks, cash, mutual funds, and guaranteed investment certificates. The more the potential return on investments you have, the quicker your tax-free savings will grow.

Better retirement planning

TFSA can accompany your personal RRSP as it offers more tax-advantaged savings. This is especially useful when you don’t have enough RRSP contribution room or you’re over 71 years of age and no longer allowed to hold your RRSP. A TFSA contribution allows any income earned in the account to be tax-free, even during the withdrawal process.   

Advantageous withdrawals

TFSA allows you to withdraw funds without paying any taxes. That’s why TFSA is considered an excellent way to save for extravagant items like a house or a car. When you want to use your savings, you can easily withdraw the cash without having to pay taxes or any additional cost. TFSA lets you enjoy that extra money to get things that matter to you.  

What TFSA investment options do I have?

TFSA allows you to hold a range of certified investment options, including the following: 

• Cash
• Bonds
• Stocks
• Mutual funds
• GICs

Each investment type offers certain advantages and disadvantages based on your goals. It is always a good idea to consult with an expert like Source Accounting Professional Corporation to find the investment option that is most suitable for you, depending on the level of risk ready to take.

Source Accounting can evaluate the options and give you the best advice to grow your funds and get the maximum benefits. 

What happens if you over-contribute to TFSA?

The contribution over the (contribution) limit will be subject to a penalty tax of 1% per month based on the excess TFSA amount in that month.

Can I contribute to my spouse’s TFSA?

You can’t contribute directly to your spouse’s TFSA as you can with a spousal RRSP. But you can give your spouse money. Your spouse can then contribute to their own TFSA directly. Any income your spouse earns on the money in their TFSA is theirs and will not be attributed back to you. If you give money to your spouse for most other investments, the income generated will be attributed to you – income attribution rules.

How much can I save with a TFSA?

There are no taxes on your income or growth within your TFSA. This ensures maximum growth and savings while using the account.

How much and when can I withdraw from my TFSA?

There is no limit on how much you can withdraw from a TFSA, and you can withdraw investment any time you want – no restriction. Withdrawals made from your TFSA will be added back to your TSFA contribution room the following year. As such you don’t lose the contribution room permanently.

How do withdrawals from TFSA impact my taxes?

First of all, withdrawal from TFSA including income earned inside TFSA is not taxable. So, you don’t pay income tax on the amounts you withdraw. Since withdrawal is not taxable, it does not impact your benefits which are based on your income (or your family income) such as the Canada Child Benefit program, the Canada Workers Benefit, GST/HST Credit, and the Age Credit.

TFSA withdrawals also won’t reduce benefits, such as Old Age Security, the Guaranteed Income Supplement, and Employment Insurance benefits.

What happens when I die?

If you designate your spouse or common-law partner as a “successor holder,” it allows them to assume your plan on your death without affecting their own TFSA. Alternatively, you may designate a spouse beneficiary to receive the funds in their plan upon your death. In this case, the spouse can transfer the value of the account at the time of death to their TSFA account without affecting their TFSA limit, however, any earnings accrued in the account, after the death are subject to tax to the spouse.

Is a TFSA different from an RRSP?

A registered retirement saving plan (RRSP) is specifically designed for retirement, while TFSA is a flexible saving vehicle that you can use for a wide range of goals. The RRSP contribution limit is based on your income (18% of your income with an annual maximum). For TFSA contribution limit is not based on income.

The contribution made to RRSP are tax-deductible, and any withdrawal is subject to taxation. On the other hand, you don’t get any deduction on the contribution in TFSA, but any withdrawal (whether original contribution or profit earned) is not taxed.

When withdrawing funds from an RRSP, your contribution room is lost once you make the contribution. It is not added back when you withdraw, subject to certain exceptions. For a TFSA, withdrawn amounts are added back to your contribution room in the following year.

A RRSP matures at the end of the calendar year in which you turn 71 –meaning you need to transfer funds to a registered retirement income fund (RRIF), purchase an annuity or withdraw money as cash (of course net of tax). There is no upper age limit for a TFSA.

Both TFSA and RRSP are excellent saving and tax planning tools. Effective use of these accounts can help you achieve your saving and retirement planning goals more efficiently. It is highly advisable to talk to your professional tax advisors to help you make a correct decision, which may have a very long-term impact. If you have any questions, please reach out to Source Accounting Team for help!

Disclaimer: The above contents are provided for general guidance only, based on information believed to be accurate and complete, but we cannot guarantee its accuracy or completeness. It does not provide legal advice, nor can it or should it be relied upon. Please contact/consult a qualified tax professional specific to your case.