TFSA Basics
What is a TFSA
A Tax-Free Savings Account (TFSA) is an account where money can grow tax-free. Although there are multiple TFSA accounts, they are similar to a regular savings account where money can be stored or invested. A TFSA allows every Canadian to invest a few thousand dollars annually without incurring taxes on any gains made within the account when leveraged correctly.
Please note that this article’s remaining information speaks to available contributions for Canadian citizens working in Canada. Additional TFSA information can be found here for individuals with another status in Canada. A TFSA can be opened by any Canadian that is 18 years old or older with a valid SIN.
Why use a TFSA?
A TFSA provides the opportunity for money to grow without being taxed, which ultimately allows the account user to keep more money from investments. Essentially, when you invest money through your TFSA into something that can return a profit, those profits will not be taxed. If the funds were invested outside of a TFSA, you would have to pay capital gains tax. A capital gain is the value that an asset increases by. For example, if you buy $1,000 worth of Amazon stock in January and sell that stock for $1,200 in December, that $200 is a capital gain. If the investment were made through your TFSA, it would not be taxed. However, if that same stock were purchased and sold in a traditional account, 50% of the profit ($100) would be added to your income and taxed at your income tax rate. Therefore, a TFSA is helpful as it allows you to grow your savings without paying a large portion of it to the government.
Contribution Limitations of a TFSA
While a TFSA is a valuable tool to reduce taxes, there is a limit to an individual’s contribution each year. For example, in 2021, the maximum amount that a Canadian could contribute to their TFSA was $6,000. Here is where contributions can get a little confusing. To start, let’s speak about the basic principles before getting into the specific information. As mentioned, every year Canadian’s reside in Canada and are 18 and above, they are eligible for the maximum contribution to their TFSA for that year.
In addition, these contributions can “stack” or add. So, if you were 18 in 2020 and 2021, you are eligible to place $12,000 in your TFSA by the end of 2021. This is because, like 2021, 2020 had a $6,000 contribution limit, which can be backfilled at any time. Since 2009 when the TFSA was first created, the contribution limits have changed multiple times. These values can be found in the table below.
Figure 1 - TFSA Allowable Contribution Limit (Source: https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/rc4466/tax-free-savings-account-tfsa-guide-individuals.html)
Let’s consider an example. If an individual turned 18 in 2014 and had never contributed to their TFSA, they would be eligible to add $5,500 + $10,000 + $5,500 + 6,000*3, or $39,000 in 2021. Also, note that the birth date does not matter, only the year a person turns 18. An individual turning 18 on December 31st is still eligible to contribute the limit for that year, even though they are only 18 for the last 24 hours of that year.
Deductions from the previous year can also be counted as contribution room for the new year’s total. If an individual withdrew $1,000 from their TFSA in 2020, their contribution room for 2021 would increase to $7,000 ($6,000 limit + $1,000 deduction from 2020). These deductions remain part of the annual contribution limit and stack over time like unused contributions.
Different TFSA Accounts with Canadian Banks
Below is a list of different account types with the various Canadian banks, which can help set eligible people up with TFSA accounts. Additional information for each account can be found on the following websites.
TD
https://www.td.com/ca/en/personal-banking/personal-investing/products/investment-plans/tfsa/
CIBC
https://www.cibc.com/en/personal-banking/investments/tax-free-savings-accounts.html
RBC
https://www.rbcroyalbank.com/investments/tfsa.html
BMO
https://www.bmo.com/main/personal/investments/tfsa/
Scotiabank
https://www.scotiabank.com/ca/en/personal/investing/tax-free-savings-account.html
Please visit the Canada Revenue Agency website for more detailed information surrounding deduction limitations, investment types, and specific examples of use cases. A good starting article with more details can be found here https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/rc4466/tax-free-savings-account-tfsa-guide-individuals.html.
TFSA vs. RRSP
A common question that people often ask is, “should I use an RRSP or a TFSA?” Of course, the answer to this question depends on your financial goals and how much money you have to save.
The primary difference between a TFSA and an RRSP is when the taxes are deducted. In a TFSA, the money you put into the account has already been taxed. For example, if you receive a $1,000 paycheck from your employer, the taxes that you owe have already been deducted when you receive that $1,000. If you invest that $1,000 in your TFSA, any money you gain will not be taxed.
However, in an RRSP, the money you invest in the account has not been taxed. For example, if your income before taxes is $1,500, you would be able to put that entire $1,500 into your RRSP without paying taxes. Instead, you are taxed when you withdraw the funds from your RRSP. The RRSP allows you to defer any taxes on your income into the future.
Essentially, in a TFSA, you invest after-tax income, and any gains on that investment are tax-free. In an RRSP, you invest money that has not been taxed, and then when you retire, you are taxed on the amount that you withdraw.
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