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TFSAs or Tax-Free Savings Accounts are the least understood and known of throughout Canada for some reason. Even if you’re not completely clear on what they are, what they do, and why you’d want one then you’re not alone. Once you do read more about this savings plan though, you will find that you might just be able to reap some great benefits from this investment opportunity plan.
Here is an overview of what to expect, what you should know, and why you should choose a TFSA for your savings plan. You might be surprised at just how easy they are to have and use, while providing you with so many benefits.
Introduced to the market back in 2009, this is a registered savings plan where any investment income that you earn is tax-free when you deposit it into your account. Not just that but taking money out of the same account is also tax-free, so you never have to worry about losing money with this type of investment account.
When you can withdraw funds from the account depends on the type of account and maturity that is placed on it. This is something to look at when signing up for the account.
Anyone who is a Canadian resident, over the age of 18 years, and has a valid social insurance number can open this type of account. However, there are provinces that may require you to wait until you are at least 19 years of age. This is again, something you have to look into for your specific account and location.
When you have an RRSP, you don’t pay money on the money that is going into the account because you get a tax deduction on any contributions that go in. However, you will be paying money on any withdrawals from the account. This is tax on any gains or income from the RRSP account.
When you have a TFSA, it works in the opposite way. You’ve already paid the tax on any of the income that you put into the account since the contributions into the account are not tax deductible. On the other hand, any withdrawals from the TFSA are tax-free regardless of how much the value has appreciated.
This makes a TFSA a great choice to go with when you might want to withdraw funds from the account during the period when you are still working, as a withdrawal from an RRSP would potentially increase the tax bracket you are in. This is also a benefit if you expect to have a very high income from your other investments once you retire. RRSPs are most effective when you can retain the benefit of applying your basic deduction and low marginal rates to any withdrawals after converting to an RRIF.
The tax-free portion of a TFSA account is often confused. Unlike with a RRSP, the money put into your TFSA is not tax-deductible. This means it does not reduce your taxable amount of income.
For example: Your income is $50,000 and you want to put $10,000 into a TFSA account, the amount of taxable income doesn’t become $40,000. This is a common misunderstanding by some considering a TFSA.
The Savings part of the account is flexible and useful. A TFSA is a registered savings plan, but it offers much more than just a savings account to put money into. If you are looking to invest your money for the short term and want a great place to do so, such as for buying a vehicle then choosing a TFSA would be the best way to go. If you want something a bit more long term, like purchasing a vacation home then a TFSA would still be the best choice to go with for investing.
Additionally, TFSA can help regardless of where you are in your life. Whether you’re just starting out, comfortably settled into life, or even retired. This plan is one that offers the most versatile flexibility out of the many accounts you can go with.
When you’re just starting out and you’re young and investing in those things that matter. You can save for a home, for a wedding, pay down your student loans and more with this type of account. It offers endless possibilities, while also growing a savings much faster because your earnings with a TFSA account are tax free.
Those settled into life can still benefit from one of these accounts. Whether it is a savings for an emergency, or to use for the vacation you’ve always wanted, or a home renovation; you can find that this type of account is perfect for these things. You can take out your money whenever you want, no penalties, completely tax-free.
Happily, retired individuals love having TFSA plans because they offer a great way to keep up some extra money. Whether you want to leave something to your children or grandchildren to help with expenses. This is that extra piece of security that so many seek during this point in their lives.
TFSAs are in essence, a versatile, easy way to invest for anyone.
This account can hold a wide range of investment vehicles that are useful to you. These accounts are dependent on your goals, income and how much risk you’re looking to take. You can hold several different stocks, bonds, ETFs, and mutual funds inside your TFSA account. These generally come with a higher yield than with cash or GICs deposited into your account.
It is always important to speak with a financial advisor who can answer your questions and ensure you’re obtaining the best information about the TFSA you’re considering opening. With their knowledge, you’re easily able to make a more informed decision on whether this is the right investment and savings asset for you to invest in.
There is an annual contribution limit in dollars that is calculated every year. It is set at $6,000 for 2022. If you do not contribute this full dollar amount into your account, then this leaves room for the unused contribution that accumulates into the account annually. Essentially, this means you can contribute more than the annual TSFA dollar amount every year, if you did not contribute over the number of last years.
The amounts roll over into the proceeding years.
Rollovers with TFSAs are important, because you want to know how much you're able to put into your account every year. When you don't put the maximum amount into the account for the year, the amount left over is then able to be added on top of the maximum amount for the next year.
So if in 2020, you only put $4,500 into your account, the next year 2021, you're able to put in $7,500 maximum into your account.
| Year | 6000 |
|---|---|
| 2021 | 6000 |
| 2020 | 6000 |
| 2019 | 6000 |
| 2018 | 5500 |
| 2017 | 5500 |
| 2016 | 5500 |
| 2015 | 10000 |
| 2014 | 5500 |
| 2013 | 5500 |
| 2012 | 5000 |
| 2011 | 5000 |
| 2010 | 5000 |
| 2009 | 5000 |
These rollovers carry across your entire lifetime, so if you turned 18 years old by 2009 and haven’t contributed to a TFSA yet, you're able to deposit up to $75,500.
If you turn 18 after 2009, you can calculate how much the maximum contribution limit is. Add the maximum contributions from the year you turned 18 together to the present year. If you withdrew any money from your account in the previous year, add that amount to the amount too. Subtract the amount from the prior years' contributions from the amount. This is your current maximum amount that can be contributed.
There are penalties for adding over the maximum amount for the year. This means you're subject to paying fines to the financial institution if you end up going over the maximum amount allowed.
This is a common question for any investment account. When the account holder ends up passing away before the amount is paid out, the beneficiary on the account is able to take over. This beneficiary, depending on the type of TFSA account, may be able to add more payments to the amount and use it themselves. They may also be able to withdraw the money from the account and close it out.
There are many factors that go into this, such as the age on the account, how much is in it, the type of account, and more. It is important to speak with the financial institution about what to expect with a death and the account.
Since the TFSA is so flexible with what you can and cannot do with it, it is one of the best savings accounts to use for emergencies should they come up. The funds are quick to get, as well making them even better for emergencies.
The biggest difference between these two accounts is that you pay taxes on the income going into the high interest rate savings account. With a TFSA you don’t have to worry about paying this interest. Some consider adding money from any taxable accounts into the TFSA account because of the tax benefits. This is a great thing to do for your overall investment strategy.
Using your TFSA as loan collateral can be done because it is one of your assets. You are unable to do this with a RRSP account. Even though the account might be locked, it can still be used as collateral. This is big when you want access to funds, you’d otherwise not be able to qualify for. This additional money in an extra account can come in handy.
When you remove money from your TFSA account, it does not count towards you as income. You won’t pay tax on it, and it won’t affect your credit or employment insurance. You also won’t suffer from not being able to get your Guaranteed Income Supplement or Old Age Security given through the government.
Overcontribution Penalties
You will want to know the rules of the capital gains and losses you can have with a TFSA account. If you take money out of your TFSA account, you can recontribute it if you have enough room available in your account. If you do not, you will have to wait until the next calendar year.
If you contribute during that same year and surpass the limit that you have, then you’re subject to a tax every month on the amount of the over-contribution that you made into the account.
For example: Rebecca opened a TFSA account in 2011 and contributed the max amount every year since it was opened. This means there is a total of $75,500 in her account come the end of 2021. When 2022 rolls around, she puts in another $6,000 which is the top dollar amount that can be added in a year. Suddenly, there is a vacation she wants to go on and takes $4,000 from her account. However, she has to cancel and can’t go.
She is not able to put this money back into the account because she has already put in the top amount allowed. She will have to wait until the next year to add this money back and it would count towards the top $6,000 so she is only able to add $2,000 more. Overall, she will be charged tax that is equal to one percent of the highest excess TFSA every month.
If there are capital gains on the EFTs, stocks, or mutual funds that are held within your TFSA account then you could potentially be taxed on 50% of the total amount without adding any capital losses to the amount for the year.
If these investments are held within the TFSA, then any capital gains earned on this money is all tax-free. Capital losses, though, cannot be claimed if they happen within a TFSA account.
Working with a financial advisor on the savings accounts or the investments you want to make. Saving money is important, but you want to do it in the most efficient, effective way possible to make it as easy as you can on yourself. A financial advisor is able to provide more insight and answer any questions you might have along the way in the process.