The TFSA – or Tax Free Savings Account – is a Canadian registered investment account introduced by the Canadian government in 2009 as a way to incentivize people to save and invest for their futures. But, a lot of people don’t use them to their full potential by investing (not just saving – seriously, who named this account?!).
So, let’s break down everything you need to know about the TFSA, how it works and why you should be using it to invest.
What Is The TFSA?
Typically, when you invest in a regular investment account, you’re investing so that your money grows – but, when you eventually sell some of your investments to use that money, you’ll be taxed on what you sell. The government of Canada has introduced a few different tax advantaged investment accounts to encourage people to invest more money – and they have different tax benefits to do that.
One of those accounts is the TFSA, or tax free savings account. Now, even though it has ‘savings’ in the name, it’s really a tax free investment account – sure, you can put money into it as savings, but that’s a waste!
We’ll get into all of the benefits in a second, but the main one is the tax free part, and the fact that the investments you have in this account is protected from taxes, should those investments grow. This is the real reason you ideally are using this account to invest, not save. If you just put money into this account, 1) it’s not doing anything for you, it’s not even necessarily earning interest unless the platform you went with had some sort of promotion, and 2) it’s taking up your room in the account on money that isn’t growing – your $10,000 in savings will still be $10,000 that you could take out tax free later on – but wouldn’t it be better to invest, profit off of your $10,000 and eventually take out $20,000 tax free instead? It would.
Benefits Of The TFSA
Now let’s get into why having a tax free account is so important and useful. The main reason is that it’s the best way to maximize your investments and how much you make from them – which can happen with interest earned (saving, bonds or GICs), dividends (certain stocks or ETFs), or capital gains (profit you get for selling a stock at a higher price than you bought it for).
If you buy those investments inside of a TFSA, all of those profits are tax free (as long as they’re Canadian investments). Now, let’s explain what we mean by ‘buying those investments inside of a TFSA’.
The TFSA is an investment account, not an investment – picture it like an empty laundry basket, not doing anything for you. Then, as you start tossing your clothes in the basket, it now has the purpose of holding them for you – you can think of your clothes as different types of investments that you can buy. So, just like your laundry basket holds your clothes, the TFSA holds your investments.
How To Open A TFSA
So, how do you actually open a TFSA and start using it? First, you need to pick a platform (now this could be a bank that you walk into and ask to set one up, or potentially a lower cost option like online banks, credit unions, investment platforms), then you open up the actual TFSA, and finally you start buying investments in the account.
Now that sounds really simple, and it can be – but there are some rules you need to know.
The TFSA Contribution Limit
TFSAs have contribution limits – this means that there’s a maximum amount of money you can contribute before it says no more clothes in the basket. This limit exists because without it, we’d all just only use this account to take advantage of it being tax free (and the government still wants us to pay some taxes).
As soon as you’re 18, as long as you’re a Canadian resident with a valid SIN, you can use a TFSA – and the year you turn 18 is when your contribution room starts to build.
Basically, every year the Canadian government decides how much more contribution room to add – it’s been $5,000 some years, $5,500, $10,000 one year, and most recently it was $7,000 per year.
The room is cumulative – so, if you don’t add in $7,000 in one year, it’s not gone forever – it adds on to how much you can put in in the next year. So, since the TFSA started in 2009, if you turned 18 in 2009 or earlier, so if you were born in 1991 or earlier, your total TFSA room is the max anyone can have at $95,000. Then, next year, when more contribution room is added for everyone, your room will continue to grow.
Withdrawing From Your TFSA
Now, let’s get back into some of the benefits of using the TFSA. We just covered putting money into a TFSA, but one of the main benefits comes up when you take money out, because you can take money out at any time without any fees or taxes.
Let’s break this down by comparing the TFSA to a regular, non tax advantaged investment account for a second. Let’s say Person #1 invested using a TFSA, and Person #2 used a taxable account – both people purchased the exact same investments at the exact same time, and made the same amount of money. But, Person #1 could withdraw all of that money and get the full amount, whereas Person #2 would have to pay taxes on it, and would get less money overall.
That leads us to the next question… if you withdraw money from your TFSA, do you lose that contribution room forever?
Can You Lose Contribution Room?
No, you typically don’t lose your contribution room forever. For example, let’s say that you have $50,000 in your TFSA at the beginning of 2024 – then, it grows (through your investments going up) to $55,000 by August and you decide to take that $55,000 out of your account. If you do that, you can’t put that $55,000 back in during that same year, but you can put it back in the next year – or anytime in the future.
But, on the other hand, if you have $50,000 in your TFSA, and it shrinks to $10,000 (through your investments going down), and you decide to withdraw that money, you can’t put $50,000 back in next year – you can only put in $10,000 – to sum that up, withdrawing your money at a loss can cause you to lose contribution room.
You also have to keep track of your contribution room yourself – technically, your account will let you put in any amount of money, but, if you over-contribute, you’ll be charged 1% of the amount you have over the limit every single month until you take it out. So, make sure you stay on top of when you withdraw and re-contribute funds.
Can You Have Multiple TFSAs?
Yes, you can have multiple TFSAs. This isn’t necessary, but if you wanted to open one to hold ETFs and one to hold GICs, or if you wanted to use two different banks or platforms, you do have that option.
But, remember that you still have one total contribution limit, so if your max room is $50,000 – and you have two TFSAs – you could have $40,000 in one and $10,000 in another, but not $40,000 and $20,000 (for example!).
Also, remember that income earned inside the account doesn’t impact your contribution room – the contribution room is just referring to the money you put into the account, not how much you make, or how much your money grows on top of that amount.
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