Introduction
The Tax-Free Savings Account (TFSA) program began in 2009. It is a way for individuals who are 18 and older and who have a valid social insurance number (SIN) to set money aside tax-free throughout their lifetime. Contributions to a TFSA are not deductible for income tax purposes. Any amount contributed as well as any income earned in the account (for example, investment income and capital gains) is generally tax-free, even when it is withdrawn. Administrative or other fees in relation to TFSA and any interest or money borrowed to contribute to a TFSA are not tax deductible.
— Canada Revenue Agency
Translation → Tax-free Savings Plan (TFSA) is an account with a financial institution (usually a bank or broker) that is designated by the Canadian federal government as a special savings account that allows you to save money TAX FREE!
Yes, you read that right, its a TAX FREE account. Well the name of the account says it right.
Whatever you save or invest in a TFSA is from your post tax income and remains tax free for the rest of your life even when you withdraw the funds.
This is essentially a bit different than the RRSP account. If you want to know more about RRSP accounts, feel free to read this article -
Are you eligible to open a TFSA account?
Any individual who is 18 years of age or older and who has a valid social insurance number (SIN) is eligible to open a TFSA.
Even non-residents with a valid SIN can open a TFSA, however any contributions made while a non-resident will be subject to a 1% tax for each month the contribution stays in the account.
You cannot open a TFSA or contribute to one until you turn 18. However, when you turn 18, you will be able to contribute up to the full TFSA dollar limit for that year.
How to open a TFSA account?
You can open a TFSA account with any financial company that allows you to save or invest your money, such as a bank, credit union, online brokers, etc.
As an example, I have my TFSA accounts with Scotiabank and Wealthsimple.
What do I do with my TFSA account?
Once your TFSA account is setup, you can do a variety of things in the account
save money
invest in guaranteed investment certificates
invest in government and corporate bonds
invest in mutual funds or index funds
invest in stocks listed on a designated stock exchange
Best part → Any interest or capital appreciation your earn in a TFSA account is not taxable even when you withdraw funds from the account.
So, my account with Scotiabank allows me to invest in GICs and the account with Wealtsimple allows me to invest in stocks and ETFs. Any interest, capital appreciation or dividends I receive in these accounts is all TAX FREE!
Is there a contribution limit for a TSFA account?
The maximum amount that you can contribute to your TFSA is limited by your TFSA contribution room.
All TFSA contributions made during the year, including the replacement or re-contribution of withdrawals made from a TFSA, will count against your contribution room.
Caution → At any time in the year, if you contribute more than your available TFSA contribution room, you will have to pay a tax equal to 1% of the highest excess TFSA amount in the month, for each month that the excess amount remains in your account.
TFSA contribution room
You will accumulate TFSA contribution room for each year even if you do not file an income tax and benefit return or open a TFSA.
The annual TFSA dollar limit for the years 2009 to 2012 was $5,000.
The annual TFSA dollar limit for the years 2013 and 2014 was $5,500.
The annual TFSA dollar limit for the year 2015 was $10,000.
The annual TFSA dollar limit for the years 2016 to 2018 was $5,500.
The annual TFSA dollar limit for the years 2019 to 2022 is $6,000.
The annual TFSA dollar limit for the year 2023 will be $6,500.
What happens to any unused contribution room from the limit?
You can use your unused contribution room to put more into your TFSA accounts at a later time.
For example, the contribution limit for 2021 was $6,000 but you only contributed $4,000 to your TFSA, you may use the unused $2,000 room to increase your contribution in 2022 for a total of $8,000 ($6000 + $2000), exceeding the maximum limit for this year.
Making withdrawals from a TFSA
You can generally withdraw any amount from the TFSA at any time. But read the following statement carefully.
Caution → Withdrawing funds from your TFSA DOES NOT reduce the total amount of contributions you have already made for the year. Withdrawals made from your TFSA in the year will only be added back to your TFSA contribution room at the beginning of the following year.
As an example, if you have already contributed $6000 for 2022, and then withdraw $2000 for a trip to Hawai, you won’t be getting back the $2000 room in your TFSA until January 2023. That means your 2023 contribution room would be $8000 ($6000 + $2000).
Replacing withdrawals from a TFSA
If you re-contribute but do not have any contribution room left, you will have over-contributed to your TFSA in the year. You will be subject to a tax equal to 1% of the highest excess TFSA amount in the month, for each month that the excess amount stays in your account.
Caution → Never over-contribute to your TFSA, unless you want to pay a fine.
Continuing our previous example, if you accidently replace the $2000 in your TFSA in 2022, you would have over-contributed and would be penalized as per the above CRA rule. You can put back the $2000 in your TFSA next year.
How much tax do I pay when I withdraw from a TFSA?
In case you haven’t read this already, you don’t pay any tax whatsoever when you withdraw funds from your TFSA!
Summary
In short,
TFSA is a great way to save and invest your money tax free.
Use it as a way to plan and invest for your long term goals.
Any interest, dividends or capital gains that accrue to TFSA account are tax exempt.
When you withdraw funds from an TFSA, you don’t pay any tax on it.
Withdrawals made from your TFSA in the year are not added back to your TFSA contribution room for the same year.
You can replace any withdrawals from your TFSA starting the next year following the year of withdrawal.
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Disclaimer: Please do not consider this post as an investment advice. I am not a registered financial advisor. Nothing in this article should be construed as an investment advice. Please consult a registered financial advisor before making any investment decisions.
Credits: Most of the content of this article is public information that can be found on news articles, government and company websites.