Tax-free savings accounts (TFSAs) were introduced in Canada in 2009 to allow residents to save and invest without paying taxes on interest, dividends, and capital gains earned within the account. They were established to help Canadians save more by offering a tax-efficient savings option.
Unlike other registered accounts, such as the Registered Retirement Savings Plan (RRSP), the TFSA isn’t just for retirement savings. Its flexibility lets people save for various goals, whether it's a rainy-day fund, a short-term need like a vacation, or major purchases such as a house or car. What's more, contributions to a TFSA do not impact your eligibility for government benefits.
Canadians are eligible to open a TFSA when they turn 18 years old. In 2022, approximately 17 million Canadians had a TFSA. If you haven’t opened a TFSA yet, it’s worth exploring how it might fit into your financial plans.
Understanding the TFSA Annual Contribution Limit
When you open a TFSA, there is a limit to the amount of money you can add to the TFSA each year. This limit changes annually due to various factors, such as inflation adjustments. In 2024, the TFSA contribution limit is set at $7,000, but it may change in the following years.
If you do not start contributing right away, your contribution limit will keep accumulating until you do. For example, if you turned 18 prior to 2009 and still have not contributed to your TFSA, your limit would reach $95,000 in 2024; it would reach $102,000 in 2025, and so on.
A single Canadian adult can open several Tax-Free Savings Accounts (TFSAs) at different financial institutions. For instance, someone might use multiple TFSAs to manage different investments. However, the annual contribution limit applies to the individual—that person's contributions across all TFSAs cannot exceed the limit.
When You Fall Short of the TFSA Limit
Don’t worry: If you didn’t contribute the maximum amount allowed in a given year, the Canadian government lets you carry forward that unused amount to future years. For instance, if you only put $5,000 into your TFSA in 2024, the remaining $2,000 will be added to your annual limits in the following years until you reach the overall limit.
Best of all, unused contribution room from previous years accumulates and can be used in any future year, regardless of how much time has passed, providing flexibility for your savings strategy.
The Impact of Withdrawals
TFSAs offer additional flexibility in terms of the TFSA limit in relation to withdrawals. First of all, you can withdraw funds anytime without penalties or taxes, no matter how much your investments have grown. Plus, any amount you withdraw in a year is added back to your contribution limit for the following year. This means you can re-contribute the withdrawn funds without losing contribution space. This feature keeps your savings capacity intact and allows for continued opportunities to grow your investments tax-free.
Investing with Your TFSA
Since TFSAs are tax free, they are a great vehicle for long-term investments. A TFSA can hold a wide range of investment products, including:
- Cash
- Stocks
- Bonds
- Mutual Funds
- Exchange-Traded Funds (ETFs)
- Guaranteed Investment Certificates (GICs)
For instance, if you invest $5,000 from your TFSA in an ETF with a 5 percent return, you'll earn about $250 each year, and that return is tax-free.
Some Canadians choose to invest funds in their TFSA to potentially grow their savings, as opposed to leaving them as cash. Just remember, a TFSA is designed for long-term savings, with dividends meant to support a financial goal. Day traders cannot use these accounts for their activities.
TFSA and Government Benefits
Using a TFSA can offer advantages for protecting your financial plans in various ways. Any income you earn in a TFSA—whether from interest, dividends, or capital gains—is completely tax-free. This means your earnings won’t impact your eligibility for federal benefits like Old Age Security (OAS) or the Guaranteed Income Supplement (GIS). This is especially helpful for retirees or anyone receiving income-tested benefits.
How to Prepare for Your TFSA
Before you invest in your first TFSA, make sure you understand the risks and requirements involved. For instance, there are limitations if you plan to move abroad and become a citizen elsewhere. You can keep your existing TFSA and earn tax-free income, but you can't contribute to it while you're a non-resident.
Also, while the income in your TFSA stays tax-free in Canada, it might be taxed in your new country, depending on their tax laws. So, it's important to research the regulations where you’ll be living.
When planning for retirement, it's important to understand how your TFSA works alongside other savings options like the Registered Retirement Savings Plan (RRSP). The RRSP is meant for retirement savings and offers tax deductions on contributions, but withdrawals are taxed as regular income. In contrast, the TFSA allows for tax-free growth and withdrawals, giving you more flexibility for different financial goals. Understanding how the RRSP and TFSA complement each other can help you align these accounts with your financial goals.
Get Started with Your TFSA
In summary, Tax-Free Savings Accounts (TFSAs) offer Canadians a flexible and tax-friendly way to save for a range of goals, whether for short-term needs or long-term investments. By using TFSAs along with other savings options, Canadian adults can improve their financial well-being and work towards a brighter future.