The Ultimate Guide to the TFSA
It’s been over 10 years since the federal government launched the Tax Free Savings Account, yet to many Canadians, it remains somewhat of a mystery. In all likelihood, that’s due to the terrible branding this government registered investment account received from the outset. I mean, it isn’t actually a savings account, after all.
In this article, I’ll do my best to clear up some of the confusion surrounding the TFSA. I’ll also show you how you can get the best use out of the account, and even cover some of the top TFSA investment options available today.
What is a TFSA?
It’s best to think of a TFSA as a ‘tax sheltered umbrella’ of sorts, under which you can invest your money any variety of ways. And while you actually can hold money in a savings account within a TFSA, it’s often more beneficial to use your ‘umbrella’ for investments that offer the potential for higher returns, such as stocks, mutual funds, or ETFs. To achieve a balanced portfolio, bonds and GICs are also available.
TFSA vs. RRSP
In a lot of ways, the TFSA is similar to the RRSP. For starters, both offer the potential for tax-sheltered growth. The main difference lies in the way you fund the accounts, and when you end up paying taxes on the money.
With an RRSP, you receive an immediate tax deduction on any monies deposited into the plan, and are taxed on the money when it’s withdrawn after retirement. With a TFSA, you don’t get the benefit of a tax deduction, but you won’t pay taxes when the money is withdrawn. Not only that, but you don’t lose your contribution room when you withdraw from a TFSA. You can deposit the same amount the following year, over and above your regular contribution.
Which is Better – TFSA or RRSP?
A popular point of discussion is whether it’s better to invest in an RRSP or a TFSA. The best answer is that it depends entirely on the individual. In general, higher-income earners will receive a greater benefit from the tax-deductibility of an RRSP, so that may be the better point of focus. I recommend that Canadians of all ages and income levels consider investing in both RRSPs and TFSAs, but tailor your strategy to what is most suitable for you.
Who Can Contribute to a TFSA
Any Canadian resident with a Social Insurance Number, who is 18 or older can contribute to a TFSA, providing they’ve reached the age of majority in his or her province. Unlike an RRSP, the contribution room isn’t linked to earned income.
TFSA Contribution Limits
For 2019, the annual contribution limit set at $6,000 and is indexed for inflation each year. The lifetime contribution limit is $63,500, for anyone who has been eligible to contribute since the TFSAs inception (2009). Your annual contribution room grows regardless of whether or not you are actively contributing.
The TFSA is unique from an RRSP in that withdrawals from the plan can be re-contributed the following calendar year. For example, if I withdraw $10,000 from my TFSA in 2019, I can re-deposit that amount as early as January 1, 2020, and still make my regular annual contribution of $6,000 that same year.
Penalties on TFSA Over-Contributions
One feature I love about TFSAs is having the ability to re-contribute any funds withdrawn in the current year, the following year. This adds to the TFSAs flexibility, making it easier to save for a variety of both short term and long term goals. However, you must use caution to avoid over-contributing to your TFSA.
More specifically, any contribution made to the TFSA beyond the maximum allowable amount is considered an over-contribution. If this occurs, the Canada Revenue Agency (CRA) will charge a penalty of 1% per month on the excess contribution until it is withdrawn.
For example, if you were to over-contribute by $6,000 for a period of 12 months, you would be facing penalties of more than $720. Staying within your contribution limit is your responsibility, and your financial institution isn’t equipped to keep track of this for you. That said, CRA does keep track, and you can verify your available contribution room any time, by accessing your CRA MyAccount profile online.
Transferring Your TFSA Between Banks
You can move your existing TFSA from one financial institution to another, by initiating the transfer from the receiving institution. Keep in mind that most FI’s charge a transfer out fee, which may or may not be reimbursed by your new provider. You also need to decide if you want to transfer investments ‘in cash’, or ‘in kind’. This may or may not be an option.
What Happens to My TFSA If I Die?
When you open a TFSA account, you’ll have the option of designating a beneficiary. The main benefit of doing so is to allow TFSA funds to go to someone you love, should you pass away, while avoiding costly estate taxes and fees. You can choose to name a single or multiple beneficiaries, who
would receive the funds from your TFSA when you die.
Married or common-law spouses also have the option of selecting their significant other as a successor holder, rather than a beneficiary, which provides some additional survivorship benefits.
TFSA Quick Facts
- Available to Canadians 18 and over
- TFSAs can hold just about any type of investment ie. stocks, bonds, ETFs, GICs
- The annual contribution limit is indexed for inflation ($6,000 in 2019)
- Lifetime contribution room is $63,500 (2019)
- Funds withdrawn can be re-contributed during the following calendar year
- Unlike RRSPs, earned income is not tied to contribution room
- Ideal for a variety of savings goals ie. (emergency fund, car, vacation)
- Spouses/common-law partners can each have their own account
Making the Best Use of Your TFSA Account
As I mentioned at the outset of this article, many Canadians use their TFSA account as an emergency fund of sorts, by placing the money in a high-interest savings account, or a GIC. This, however, is not the most efficient use of a TFSA as a tax strategy.
Since you do not pay taxes on TFSA withdrawals, and your money grows tax-free, it is more advantageous to allocate high yielding investments within your TFSA. Lower yielding investments would be better suited inside an RRSP or a non-registered investment account.
Where Should I Invest My TFSA
If you’re a fan of low cost investing like we are here at MapleMoney, I recommend the following two options to invest your TFSA.
If you value low fees but prefer a hands-off approach, you might want to consider the services of a robo-advisor. While the term itself may make some investors nervous, Canadians are becoming more comfortable with robo-advisors every year, thanks to companies like Wealthsimple.
Wealthsimple is Canada’s leading robo-advisor, with over 4.3B in assets under management. When you open an account with Wealthsimple, they will invest TFSA funds in a portfolio of consisting of low-cost ETFs that are aligned to your recommended asset allocation. With Wealthsimple, you’ll only pay .40% up to $99,999, and your initial $10,000 is managed for free.
If you prefer to make your own investment decisions, managing your own TFSA online through a discount brokerage can be a great option. A self-directed account from Questrade enables you to hold all of those high yield investments I mentioned earlier, like stocks, ETFs, and mutual funds.
What I love about Questrade is that they combine a state of the art trading platform with some of the lowest fees in the business. In fact, Questrade does not charge fees for ETF purchases, which alone is enough to make them #1 in my books. You can open a TFSA account with Questrade within a few minutes, from the comfort of your living room, and be on your way.
Final Thoughts on TFSA Accounts
If prior to reading this article, you were like many Canadians and found the concept of Tax Free Savings Accounts a bit confusing, my hope is that I’ve provided some much-needed clarity. I think that once you realize that the TFSA is more or less a tax shelter, inside which you can hold a wide range of investments, it makes everything that much easier to understand.
Great article about TFSAs. I would like to know what the tax implications are for TFSAs when it comes to leaving a beneficiary or leaving the TFSA to you estate in the end?
Smac20, if the beneficiary is a spouse or common-law partner, the TFSA remains intact and tax-exempt. If someone else is designated, the TFSA will no longer exist, but the portfolio’s growth will have been tax-free up to that point.
Hi Tom does a TFSA have a limit to what it is not taxed at? Is it similar to the ISA in the UK that allows you to earn interest on up to £3600 a year tax free?
There is the $5000 a year limit on what can be put in, but no limits on how much you can make without paying tax. Any interest, dividends, capital gains, etc. are tax free.
Any thoughts on which financial instititution would be best for stocks TFSA? i see the banks on higher side of fee and questrade being cheap but at the same time, is quest trade reliable? why people still go to banks if questtrade is cheaper? any thoughts
Bottom line you need to remember about banks is that they are a business; and like any other business these days they are concerned with their bottom line. In my opinion most people go with banks because banks are familiar, well known, easy, and generally make you feel comfortable. Not because they are the best way to go. If you are comfortable being responsible for managing your stocks, etc then you could go with something like Questrade. Otherwise you can often get access to professionally managed investments through a financial adviser.
see the banks on higher side of fee and questrade being cheap but at the same time, is quest trade reliable..Savings Guidance
Hi there, Great article. Finally understand the difference between TFSA and RRSP.
Probably you have answered this, but to clarify, if I put $5000 into a TFSA and invest in (non-dividend) stocks, and the return grows the $5000 to $5500 during the same year, is the $500 taxed because its over the $5000 limit? In other words, does the limitation only apply to the original investment?
I think the TFSA is an awesome way for retirement savings or an emergency fund, in the long run a much better tax advantage than your traditional RRSP.
Any capital gains/dividends/interest payout from the investments is tax free and it does not count towards the yearly contribution. http://www.tfsa.gc.ca/.
You can have multiple TFSA accounts, as long as the total money you transfer or contribute does not exceed the yearly maximum or carry-forward from previous years.
My current strategy is a TFSA brokerage account set up with DRIP (dividend re-investment plan) with my bank, holding various ETF’s (Exchange Traded Funds). ETF’s are like mutual funds, but usually have much lower management fees than RRSP funds and they trade like stocks. With DRIP, the dividend payout will automatically purchase whole shares of the stock or ETF (providing the payout is at least the current value of the share/ETF price). There are no additional fees for this service. Some ETF’s pay monthly or once a quarter.
The dividend payouts on most ETFs are usually more than those “high interest savings accounts” or GIC’s.
A great website for research on some Canadian ETFs and model portfolios can be found on http://canadiancouchpotato.com .
Good job in clarifying! I’ve heard many people say that they haven’t invested in TFSA’s because “TFSA’s don’t earn much interest”. They think a TFSA is a specific investment! So not true.
You stated: “Not only can you withdraw the money and replace it at any time,..”
Be very careful here!!!
As you know, each year there is a limit as to how much that one can contribute to a TFSA (currently it’s $5500). If you contribute the maximum in any given year, then withdraw any amount of money, and then decide to replace any of that withdrawn money “all in the same year” – then you are taxed big time by the Feds!!! You can only repay the withdrawn money in any year “following” the year of withdrawal.
In the first year that the TFSA program was introduced to Canadians many people were not aware of this rule and were taxed. Often the financial institution handling one’s TFSA account does not clearly make this fact known to new TFSA enrollments. It was a learning curve for many folks.
I routinely transfer investments (stocks, bonds, mutual fund shares, GICs, cash, whatever) from my taxable accounts over into my TFSA account, up to the yearly contribution limit, each January in order to tax shelter the interest gains that these investments produce. I highly recommend them. They are not just simply cash saving accounts and, unlike RRSPS, you can continue to contribute to them past age 71, without being required to start withdrawing any funds, unless you so desire.
I like the idea of market linking both the RRSP and the TFSA to a low-fee Index Fund account like that of ING’s. The tax savings you get from contributing to the RRSP can also be allocated to the TFSA.
For your interest, one way of looking at an RRSP is that it is equivalent to a leveraged TFSA, that is to say, equivalent to using your own money plus a government loan to invest in a TFSA. The government loan part of an RRSP is the so-called “tax refund.” The interest rate the government effectively charges on this tax refund loan depends on the difference between tax rates at contribution and withdrawal dates and the time that the money is invested in the RRSP.
Very enlightening post. The designation of this type of account speaks for itself yet also very misleading if one don’t pay serious attention about its nature. Thanks for your guidance.
Does anyone know what the actualy penalties are for over-contributing to a TFSA? Let’s say I put in $6500 when I only had $5500 in contribution room for the year.
Would the principle of the extra $1000 be hit by CRA, or would I simply be taxed on the interest the $1000 earns in the same way I’d be taxed on a non-TFSA investment?
Nobody that I’ve spoken to seems to know. I even talked to my bank at one point and they didn’t want to tell me (I no longer to business with that bank for a multitude of reasons)
When in doubt, simply Google for the answer. Here’s the relevant CRS webpage answer:
“If, at any time in a month, you have an excess TFSA amount, you are liable to a tax of 1% on your highest excess TFSA amount in that month.”
Another Interesting Facts about Tax Free saving is contribution room and research credit you found from this.
How about Index Linked GIC product to shelter cap-gains?
There are many ways of looking at TFSA’s and a helpful one is to compare them to other investments, and very definitely RRSP’s.
It was mentioned in one of the above comments that if a spouse is set up as the Beneficiary, the amount in the deceased’s TFSA at the time of their death passes to the survivor as a TFSA, even if the result increases the survivor’s TFSA to more than in total they could have contributed to a TFSA; similiar to a RRSP.
Both TFSA & RRSP can be used for retirement funding; which is better, may vary with an individual’s taxable income, both at time of contribution and withdrawl. For people with low taxable income, TFSA’s may be better because they completely eliminate income tax at time of receipt, and they may not benefit from the RRSP tax deduction.
One point that isn’t mentioned is that if your retirement fund includes dividend paying US stocks, you lose a US withholding tax if you invest in a TFSA, which you don’t in an RRSP (assuming W-8BEN is filled out.)