A Detailed Guide to a Tax-Free Savings Account (TFSA)

When looking to protect your personal finances, embracing financial tools that benefit your immediate and long-term financial future should be high on the agenda. That said, if you live in Canada, a tax-free savings account (TFSA) should be one of your top priorities.

An Introduction to Tax-Free Savings Accounts (TFSAs)

The TFSA account was first introduced in 2009 and is defined by the Government of Canada as “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”. 

It is a type of account that is open to any Canadian resident who is at least 18 years old and possesses a valid social insurance number. It enables individuals to embrace tax-free contributions, capital gains, interest, and dividends as their TFA withdrawals will be exempt from taxes - although admin fees may still be incurred depending on your choice of issuer.

While referred to as a savings account, a TFSA can hold cash, stocks, bonds, guaranteed investment certificates, and mutual funds.

Why Open a TFSA?

Before looking at how to open a TFSA, you should familiarise yourself with the reasons why having a TFSA account is a good idea. The main incentive is that it’s a chance to set money aside for a range of life situations while knowing that you won’t be taxed on any TFSA withdrawals.

Perhaps one of the best ways to understand the benefits is to look at an example.

• Person A invests $5,000 into a standard investment account, while Person B invests $5,000 into a TFSA. Both investments yield a 10% ROI.
• While both now have $5,500 to withdraw, Person A will be taxed on the $500 capital gain. Meanwhile, Person B can withdraw the full $5,500 without tax.

As a TFSA holder, you can also benefit from the flexibility of being able to withdraw funds for any purpose while also being able to add money back into the account after a withdrawal, although it should be done during the next tax year. 

The fact that your TFSA contribution room resets at the start of each year makes it a good option for short and mid-term financial goals like saving for a home deposit. Many TFSA holders also like the fact that there are no mandatory withdrawals, meaning the funds can potentially be left to grow for life. By designating a successor to your account, the chosen beneficiary can accept the funds without impacting their TFSA.

Understanding the TFSA Contribution Limit

When opening a TFSA account, it is important to avoid excessive contributions as the Canada Revenue Agency will charge a 1% tax for each month that the funds remain in the account - unless you formally commit the extra funds towards the following year’s contribution. So, how much can you deposit into a TFSA?

When this type of account was first introduced, the annual limit (also known as the TFSA contribution room) was $5,000. TFSA contributions were raised to $5,500 in 2013 before increasing to $10,000 in 2015. This reverted back to $5,500 in 2016 before climbing to the current $6,000 limit in 2019.

If you do not reach the annual limit, next year’s limit will be increased. Similarly, any withdrawals made in one year will increase the potential limit of the following year’s deposits. For example;

• If you only deposit $5,000 of your $6,000 limit in 2023, you will have the opportunity to add an extra $1,000 in 2024. This means a limit of $7,000 unless the figures change for 2024.
• When you make a TFSA withdrawal of $2,000 in 2023, you can still only deposit $6,000 in 2024. However, it will enable you to deposit $8,000 in 2024, unless the annual fee for 2024 was to change.

While you may still need to diversify with additional savings and investment accounts, the tax-free withdrawals and the ability to use multiple financial vehicles makes it a very useful product that all Canadians should aim to utilize.

Another question that people might ask is: What is the lifetime limit for TFSA holders? And the short answer is that there isn’t one. When added to the fact that you can re-contribute any funds withdrawn from the account as early as the next financial year, it’s easy to see why TFSAs are so popular.

It is also possible to hold multiple TFSAs - perhaps for different financial goals - but you must not fall into the overcontribution trap. If you have deposited $4,000 into your first TFSA, you can only deposit $2,000 into the second one without encountering the 1% tax fines mentioned above.

TFSAs vs. RRSPs

When considering additional financial tools to use as a substitute or supplement to your TFSA, a registered retirement savings plan account is one of the most likely choices. 

The obvious difference between the two is that TFSA accounts can be used for any purpose, while an RRSP is specifically designed with retirement savings in mind. As far as the financial aspects are concerned, the two products work in a direct inverse of each. Your RRSP deposits are tax-deductible, while TFSA ones are not. However, a TFSA benefits from no tax on withdrawals, whereas RRSP withdrawals are taxed.

Understanding how both items work can help you build a better tax savings strategy that will unlock improved financial health for the immediate and long-term future. In many cases, individuals will use both products - potentially with additional items for portfolio diversification.

Additional Things To Know About Holding a TFSA Account

By now, you should have a fairly strong grasp of the benefits of TFSA accounts, but it’s important to understand every single contributing factor. Over 15 million Canadians have a TFSA, and before opening yours, you should know the following:

• You can contribute to a spouse’s TFSA without impacting your personal TFSA contribution room. Likewise, they can contribute to yours.
• TFSAs are only offered to residents living in Canada who also meet the age and social insurance number requirements. 
• If you lose your resident status, you can still access your account but cannot make further deposits.
• You can use TFSA balances as the security for your loan agreement. 
• TFSA withdrawals can be transferred to another individual through a Breakdown of Marriage or Common-Law Partnership form under Financial Institution rulings.
• Most TFSA providers allow you to make contributions both online and in-branch while also facilitating easy management.
• A TFSA account can only be opened by an individual applicant for personal matters and is not open to joint applicants. 
• In some provinces, the minimum age for opening a TFSA is 19, not 18.

Furthermore, TFSAs will not invalidate your eligibility for federal income-tested benefits, making it a suitable option for investors from a wide range of backgrounds. It can be particularly useful for low-income senior citizens.

How To Open a TFSA in Canada

Once you’ve decided that a TFSA account would have a positive impact on your financial future, the next step is to open one. Thankfully, the process is relatively simple and includes the following three steps:

• Find a financial institution or issuer that offers a TFSA and submit an application.
• Provide the supporting documents such as your date of birth, social insurance number, and background info to see if you qualify for a TFSA.
• Complete the consultation either in person, over the telephone, or online to confirm that your TFSA can be set up. At this time, you can also arrange your first deposit.

It’s very important to keep in mind that an error during the application could invalidate the TFSA. In turn, this would mean that any capital growth would be taxed as if it were in another type of investment account. 

Some of the biggest and best issuers include EQ Bank; Tangerine; Alterna Bank; Motusbank; and Questrade. 

Meanwhile, a self-directed TFSA means that you’d be managing your own investment portfolio rather than allowing the issuer to act on your behalf. It is something that must be discussed with the issuer before opening the account.

A TFSA is a personal savings and investment account, but it is also possible to authorize your spouse, common-law partner, or accountant to provide details on your behalf. The authorization can last until a predetermined date, a confirmation that you want to end the agreement, or in the event of your death.

How Much of an Impact Could Opening a TFSA Make?

Many people open a TFSA account without any defined goals. However, many others will use the account specifically to prepare for their retirement, save money for a new car, secure a downpayment on a property, or add to their child’s college fund. Whatever the intended purpose may be, you will naturally want to know how much of a boost this type of account can provide.

Rough guides suggest that the following benefits can be seen in comparison to non-registered investment accounts:

• Over 5 years, you could see a benefit of around $1,750.
• In 10 years, you could see a benefit of around $7,500.
• In 15 years, the benefit could increase to around $19,500.
• Over 20 years, the benefit could increase to around $40,750.

The figures show that TFSAs can provide a solid financial boost even over a short period of time. Nonetheless, opening the account at an earlier age with the intention of developing a long-term investment strategy will make for the best results by far.

Final Thoughts on Having a TFSA Arrangement

While a TFSA is not tax-deductible, the fact that you won’t be taxed on future withdrawals or capital gains makes it a valuable tool to have in your arsenal. As long as you take care not to surpass your TFSA contribution limit, it can have a positive impact on your personal finances with both immediate and long-term results.

With over 15 million Canadians already using this financial tool to enhance their financial flexibility and security, now is the perfect time for you to think about doing the same.