A Guide to the Tax-Free Savings Account (TFSA) in Canada

A Tax-Free Savings Account (TFSA) is a tax-free investment account that Canadians can use to invest and save for future expenses. This is my all-time favourite account in Canada and will likely be your favourite too! This account has one key aspect that changes everything about saving your money: you do not pay withholding taxes on the interest earned when withdrawing your money. It's an investment vehicle that allows Canadians to invest money and withdraw their profits tax-free.

An overview of the TFSA

What is a TFSA?

A Tax-Free Savings Account (TFSA) is a Canadian financial savings program that allows Canadians to set aside money in their account tax-free. You've already paid taxes on the money invested, so you don't need to pay it upon withdrawal! In this case, any interest earned on Canadian investments on the TFSA is not taxed. Any income earned in the account is tax-free. However, the exception is for US stocks dividends which are taxed at 15%. 

The main goal of investing with TFSAs is to make investments that may earn higher returns over the long run as part of your retirement savings. It's generally money that you will only use in the future as it increases more and more over time, thanks to the magic of compound interest. If you need the money, however, you can always withdraw it at any time. 

How Does A TFSA Work?

You can think of a TFSA as a savings account on steroids... if used properly.

When you open a TFSA, you get to contribute up to your allowed contribution limit, and you can watch your money grow exponentially over the years. The best thing about it is that it's all tax-free as its name entails.

So if you put $1,000 into a TFSA this year and you gain $1000 in capital gains because your investments have doubled in value, you keep all of it!

The second best thing is the TFSA's flexibility. Unlike the Registered Retirement Savings Plan (RRSP), you can withdraw your money any time you want. If there's an emergency and you need your money as soon as possible, your TFSA has your back.

But, you won't be able to contribute that same amount back until the next year unless you already had enough contribution room left.

If you don't have enough contribution room this year, you'll get to contribute that amount back in the next year since it gets rolled over. We'll go over TFSA withdrawals shortly.

Before opening a TFSA, make sure to look at this year's contribution limit, the previous limits and where you stand (when you turned 18 years old in Canada).

That's because TFSA over contributions come with a penalty: one percent of the excess contribution every month until it's withdrawn.

The best way to benefit from the tax-free earnings is to use the TFSA as an investment account instead of a savings account.

I made the mistake of using my TFSA as a savings account when I first created it, and I missed out on many potential gains because I let my money sit there earning the not-so-high "high-interest rates" banks offer.

Are you eligible for a TFSA?

You must be a Canadian resident who's 18 years old or older, or the age of majority in your province of residence to open a TFSA with a bank or a brokerage. You must also have a valid Social Insurance Number (SIN).

How to open a TFSA?

Anyone 18 years of age or older with a valid social insurance number (SIN) can open a TFSA. You can contact any financial institution or brokerage, provide your SIN, date of birth, and they'll be able to open one for you. You may need to show documents to prove your identity and residency. 

You can open as many TFSAs as you want, but it may become hard to keep track of your contributions!

There are many financial institutions out there, so you must make sure that you know what your options are. Some require a minimum amount, while others don't. This way, you won't miss the chance to contribute on a whim. Some also need you to have a bank account with them, while others do not. 

I use Questrade and Wealthsimple as they are great and I haven't had any problems. You can choose the brokerage you want and even open your TFSA with your preferred bank. 

What are the main benefits of a TFSA?

There are many benefits to contributing to a TFSA. 

Here's a list of why you should open a TFSA:

• More money for retirement: Contribute now, and your money will grow exponentially by the time you retire.
• Tax-free withdrawals: You can withdraw funds from your TFSA without paying any taxes.
• Compound interest: Your investment grows on top of any initial contribution. The sooner you contribute, the better!
• No minimum balance: You can contribute as little as $1.
• Unused contributions carryover: You won't lose any contribution even if you haven't made any since you've turned 18. It's never too late!

TFSA Rules Overview

TFSA contributions

There is a maximum contribution limit for each year. You may contribute as much as you want as long as you have the contribution room. 

Your contribution limit will depend on your age. More specifically, the age that you turned 18 years old in your province on or after 2009.

Since its creation in 2009, the TFSA has had an annual maximum contribution limit. 

Here is the breakdown of the annual contribution limit since 2009:

2009 to 2012 - $5,000

2013 & 2014 - $5,500

2015 - $10,000

2016 to 2018 - $5,500

2019 to 2022 - $6,000

Fortunately, your unused contribution limit carries over to the following year, so you never lose it.

If there is an excess contribution to your TFSA account, you must remove it as soon as possible, or you'll be charged 1% of the excess as interest each month! For more information about this, make sure to consult the CRA website.

If you're unsure where you stand and you've never contributed any money to your TFSA, you can use this contribution limit calculator to determine your contribution limit. The CRA can also provide you with your remaining contribution limit if you log in to your account. 

What is the TFSA contribution limit for 2021?

The TFSA contribution limit for 2021 is $6,000.

What is the TFSA contribution limit for 2022?

The CRA (Canadian Revenue Agency) has announced that the TFSA contribution limit for 2022 is also $6,000.

TFSA Withdrawals

You can use any funds in your Tax-Free Savings Account at any time without paying taxes on it – even if you withdraw all the money from your account. 

If you make a withdrawal in a given year, you will be able to re-contribute it the following year. 

So, if you withdraw $10,000 from your TFSA this year, that contribution room will be available in the next calendar year as of January 1st.

In addition, if you turned that 10,000$ into 50,000$ and decided to withdraw it all, you totally could, and it would be tax-free! The best part is that you'll be able to re-contribute that 50,000$ the following year.

How to invest in a TFSA

You can invest in many things, including stocks, mutual funds, ETFs, bonds, etc. The goal is to make your money grow over time and ensure that it's safe, secure and has low risk.

It's essential to diversify your investment portfolio to reduce the chances of losing a large sum of your money if an investment does go south. 

If you don't know anything about investing, you can still invest your money in an ETF with low fees or Wealthsimple's robo advisor which does it all for you for very reasonable fees! That's how I started investing in my TFSA. I earned decent interest during my first year of investing with Wealthsimple's robo advisor while learning more about investing and very low fees.

TFSA vs. RRSP

Ah, the most popular question: should you invest in a TFSA or RRSP?

The short answer is that it depends on your financial situation and goals.

Both the TFSA and RRSP are great retirement vehicles, and ideally, you should make the most out of both because they have their advantages.

The RRSP is generally preferred when you are saving for retirement, are earning over 50,000$ and do not need the money invested until retirement. At this point, you can take advantage of the tax deduction granted from investing in your RRSP. With the RRSP, the money you invest is not taxed; however, it will be taxed when you retire and withdraw from it.

By then, your income is expected to be lower, and therefore your withholding tax will be lesser than it is now. Your money will grow over the years, and you will likely pay less taxes when you withdraw it at retirement.

One thing to note about the RRSP is that you cannot withdraw your money whenever you want. You can withdraw it as part of the Home Buyer's program or at retirement; this is important to think about if you're going to need the money soon.

The TFSA is generally better if you have a lower income and plan on making a big purchase in the near future. Remember, with the TFSA, you can withdraw your money tax-free at any time. This flexibility is great when you plan to buy a car, a house, or any other big-ticket item soon.

Is a TFSA right for you?

The TFSA is designed to be a savings account where a portion of your income can be set aside, invested, and then withdrawn at a later date when needed. The TFSA is an excellent option for those who are saving for retirement, want to build a financial portfolio, and are looking to save for a longer period of time. The TFSA can be an incredible investment vehicle thanks to its unique tax benefit that allows your money to grow tax-free.

A TFSA is a great way to build a nest egg that you can use later in life without waiting for retirement. You can begin to make this financial nest from the young age of 18 and benefit from an early start through compound interest.

In short, if you are a low to medium income earner and plan on using this money later (which is usually the case when you're in your 20's), the TFSA is a great option to begin saving and building your wealth!

The Takeaway

In conclusion, the TFSA is a great investment vehicle for those looking to build wealth for both retirement and future expenses.

You can invest your money, let it grow and feel free to withdraw your money whenever you want. You can then re-contribute that money the following year. This flexibility is great when you're earning a low to medium income and will need the money shortly.

I wish I had opened my TFSA and began investing at 18 years old because what matters is the time you spend in the market. Make sure to research, educate yourself and take the jump once you're ready! 

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