Tax-free savings accounts (TFSAs) have been around since 2009. But they can be used as more than just a plain old savings account.
What a TFSA is and how it works
A TFSA is a registered account that can hold cash, GICs, stocks, bonds, mutual funds (including index funds), and exchange-traded funds (ETFs). In other words, it’s really a tax-free investment account.
Like an RRSP, a TFSA is a tax-sheltered account. That means if your investments produce income or capital gains, they’re not subject to tax as long as they remain in the account.
If you have a valid social insurance number (SIN) and are at least 18, you can open up a TFSA. Due to the age of majority rules in British Columbia, New Brunswick, Newfoundland, Northwest Territories, Nova Scotia, Nunavut, and Yukon, you can’t enter into a contract, which includes opening a TFSA, until age 19. However, any contribution room earned is carried over to the next year.
Every Canadian gets the same amount of contribution room each year. And any unused contribution room carries forward indefinitely. But unlike an RRSP, you don’t get a tax deduction on contributions.
The amount of contribution room has varied over the years. It was initially indexed to inflation and rounded the result to the nearest $500. However, the limit was increased to $10,000 in 2015 and inflation indexing was removed. And in 2016, the limit was lowered back to $5,500 and indexed to inflation again.
If you were 18 or older when TFSAs were introduced in 2009, have a valid SIN, and you’ve never contributed to a TFSA, you now have $52,000 in contribution room.
Tax-free withdrawals can be made at any time for any reason and the amount you withdraw can be re-contributed in future years. If you re-contribute the amount withdrawn in the same year and you’ve already contributed the lifetime maximum amount to your TFSA, your re-contribution is considered to be an over-contribution and you’ll be subject to a tax penalty.
Reasons to use a TFSA
TFSAs can be used for different savings goals, such as:
- Saving for a home—If you’re a first-time homebuyer, you can save for a home in a TFSA instead of an RRSP. When you take advantage of the Home Buyers’ Plan and take out money from your RRSP, you must pay back the amount withdrawn. With a TFSA, you never have to repay the money that was withdrawn. Also, there’s no limit on how much you can withdraw.
- Saving for an education—If you want to further your education, you can save in a TFSA. Although you’re allowed to use the Lifelong Learning Plan (LLP) and withdraw money from an RRSP, there are some limitations. For example, you must be a full-time student (part-time studies are eligible if you meet one of the disability conditions) and enrol in a qualifying educational program. And you can only withdraw up to $20,000 in total. That’s not even enough to get an MBA from the Rotman School of Management in Toronto. According to Canadian Business, the tuition is more than $100,000.
- Saving for retirement—TFSAs can also be used to save for retirement and are better than RRSPs for low-income Canadians. As TFSA withdrawals aren’t considered to be income, it won’t result in clawbacks of Old Age Security (OAS) and Guaranteed Income Supplement (GIS) benefits. You can continue to save in a TFSA during retirement whereas you can only have an RRSP until age 71.
The bottom line
A TFSA can be used as part of your overall savings and investment strategy. It’s also more flexible than an RRSP.