All About Tax-Free Savings Accounts

All About Tax-Free Savings Accounts

Did you know that a Tax-Free Savings Account (TFSA) isn’t really a savings account? Instead, a Tax-Free Savings Account is more like a basket that holds many financial options. In your TFSA, you can choose to include exchange-traded funds (ETFs), guaranteed investment certificates (GICs), stocks, bonds, and of course, actual savings. The best part is that any money you make from the investments in your TFSA is tax-free!

In 2009, the Canadian government introduced TFSAs to encourage people to save money for retirement. Since you pay tax on the money you put into your TFSA, you won’t have to pay anything when you take that money out.

TFSAs are great tools for growing your finances and setting up a cushion for retirement, but they do come with specific rules and limitations. So here’s everything you need to know about TFSAs:

What is the Contribution Limit?

You’re only allowed to open a TFSA or contribute to one when you turn 18 (in some provinces and territories you cannot contribute to a TFSA until you’re 19). Once you turn 18, you’re allowed to contribute $6,000 per year (as of 2019). However, if you don’t contribute the full $6,000 per year, you can carry forward the unused contribution amount and add it to the TFSA contribution limit for the following year. In 2018, the contribution limit was $5,500, so if you didn’t put any money into your TFSA in 2018 or 2019, then in 2020, you can contribute $11,500.

What’s more, if you withdraw money from your TFSA in one calendar year, it’ll create additional contribution room for the following year. For example, if you put in $6,000 in 2019, but then you withdraw $1,000 in 2019, you can contribute $7,000 in 2020.

What If I Exceed the Contribution Limit?

If you overcontribute to your TFSA, then the Canada Revenue Agency (CRA) imposes a tax of 1% per month for each month or partial month that the excess amount stays in your TFSA.

The 1% tax applies until:

  • You withdraw the entire excess amount; or
  • For those who are eligible, the entire excess amount is absorbed by additions to their unused TFSA contribution room in the following years.

For more information, you can visit the CRA website.

What Are the Benefits of a TFSA?

The main benefit of a TFSA is right in its name: you don’t have to pay any taxes on the money you make on it. For instance, if you invest $5,000 in your TFSA, and it grows to be $15,000 by the time you retire, the extra $10,000 of income is 100% tax-free.

Another advantage to using a TFSA is that unlike your Registered Retirement Savings Plan (RRSP), you can quickly and easily withdraw money at any time. There is no penalty when you take money out of your TFSA. Plus, withdrawing cash allows you to contribute more the following year, as mentioned above.

Lastly, since the TFSA was designed to help build income for retirees, once you retire, you can withdraw your money from your TFSA, and it won’t affect your retirement benefits such as Old Age Security, which decreases when you have a higher income.

How Can I Open a TFSA?

If you’d like to open a TFSA, you must be a resident of Canada with a valid social insurance number (SIN) and be at least 18 years of age. There are four types of TFSAs available:

  • A deposit
  • An annuity contract
  • An arrangement in trust
  • A self-directed TFSA

You can have more than one TFSA at a time, but the total amount you contribute to all your TFSAs can’t exceed your available TFSA contribution room for that year.

To open a TFSA, get in touch with your bank, credit union, or insurance company (issuer) and present the issuer with your SIN and your date of birth. This way the issuer can register your qualifying arrangement as a TFSA.

Can TFSAs Benefit Business Owners?

As a business owner, you might opt to leave extra funds in your corporation for investing. However, according to a report by CIBC, if you decide to take those additional funds out of your corporation and invest them in a TFSA, you’ll generally end up with more after-tax cash, especially if you have a long time horizon for the investment.

How Can the Number Works Help?

It’s a good idea to discuss the above with a professional accountant. So if you’re looking for an affordable virtual accounting firm, look no further than The Number Works! We partner with small businesses and creative entrepreneurs who are looking to grow their businesses and profits.

We offer a wide range of services such as full cycle accounting, financial statement analysis, strategic planning, and tax planning. So if you have a question about TFSAs and how they can work for your business, don’t hesitate to get in touch with us today. We love helping you tell your financial story.