The Tax-Free Savings Account, or TFSA, was first introduced to Canadians in 2008, to come into effect January 1, 2009. The maximum contribution limit was $5000.
The account was a way for the Canadian government at the time to encourage personal savings, tax favoured, but without the same restrictions of the RRSP.
But what is a TFSA really?
There seems to be confusion about what a TFSA is, what it can be used for, how the money in a TFSA can be invested… and so I’m hoping to bring some clarity to those questions I address with clients all year long.
What makes a TFSA a TFSA?
When you invest outside of a RRSP in Canada, you have to pay capital gains tax on the investment earnings each year. In a TFSA, those investment earnings are not taxed. The TFSA is a registration of an investment contract… like an RRSP is a registration of a contract. Registration means that the investment is attached to your SIN number when you open it, so that the Canadian government doesn’t charge you tax for the investment earnings on those monies.
Since it has these tax advantages, TFSAs have annual contribution limits (currently $5500), with any unused contribution room carrying forward to your next year, similar to the RRSP contribution limits. In 2018, any individual new to contributing to a TFSA can allocate up to $57,500 without penalty. Over-contributions are penalized if not withdrawn. TFSA’s are available for any Canadian age 18 or over, whether an individual is working or not (great for retirees).
What can a TFSA be used for?
You name it! An individual can open as many TFSA accounts as they’d like, but use stay within the contribution limit across all contracts. I’ve helped client open a TFSA for short-term savings, for their minor child to have an opportunity to invest tax strategically, or for long-term savings for retirement to accompany their other retirement savings strategies. The flexibility around the withdrawal of funds within a TFSA allows it to work for any saving goal.
In retirement planning, TFSA’s can provide a flexible, income-tax-free income stream or available lump sum funds through retirement. RRSP’s and pension funds carry restrictions where minimum and maximum withdrawals are concerned, and are fully taxable. Fund your world travels, grandchildren gifts, and more through a TFSA.
How can a TFSA be invested?
You’ve likely seen advertisements at your bank or on television stating a 2.5% (or similar) interest rate for a TFSA account. This is merely a high-interest savings account offer (in these low interest rate days). However, don’t sell yourself short. You’re not having to pay tax on the investment gains in a TFSA, so why wouldn’t you want to maximum the potential for gains? You can invest a TFSA account just as you would any other investment – in accordance with your investment risk profile. Be a little more aggressive then what the banks are offering… it’s worth it.
Now that we’ve covered the basics…
Some FAQs about TFSAs:
Can I transfer an RRSP or LIRA pension funds into a TFSA?
No. Those types of contracts are already registered under their own legislation. In order to transfer those monies into a TFSA, you’d have to withdraw/cash out and pay tax accordingly on those monies, and why would you? You’ll be taxed as you withdraw as income during retirement. Instead, allocate some of your after-tax dollars towards a TFSA for retirement income flexibility to add to your structured income plans that a RRSP and LIRA/pension provide.
Will it cost me to withdraw from my TFSA?
There is no tax withholding or income tax you’ll have to pay on any money you withdraw. Depending on where and how you’ve invested, there may be some sales charges (talk to your financial advisor to see before you withdraw).
If I withdraw from my TFSA, does that open up my available contribution room?
No. Similar to an RRSP, once you’ve used that contribution room up it’s gone, whether you withdraw funds from your TFSA or not. Keep track of your contributions though, as over-contributing has a penalty.
Still unanswered questions, or want to know if a TFSA should be included in your financial plan? Contact me for a complimentary coffee chat!