Awa Sow
As important as saving is, finding the right savings account is also as equally important. This is to make sure that you take advantage of the best possible way to save, in order to reach your goals as quickly and as efficiently as possiblee.
Did you know that there is an account called the Tax-Free Savings Account (TFSA) that allows Canadians to save money tax free? So what exactly is a TFSA?
What’s the Tax-Free Savings Account?
The Tax Free Savings Account (TFSA) is a registered savings account with the Canada Revenue Agency (CRA). The account was created in 2009 in order to help Canadians save. Because this account is 100% tax free, it helps you grow your savings much quicker. It allows any eligible Canadian to save money and earn as much interest as possible while not having to declare the interest earned or pay taxes on it.
What’s the difference between the TFSA and a regular savings account?
The main difference between the Tax-Free Savings Account and a regular savings account is the taxable interest. Did you know that Interest earned in a savings account is not tax free? Meaning that you have to declare any interest earned in a savings account and pay taxes on the amount because it’s considered investment income.
Unlike the RRSP, your TFSA contributions are not deductible for income tax purposes. This means that you won’t be able to declare the amount you are contributing to your tax free savings account to reduce your overall income before-tax.
While you can deposit and withdraw as much money as you want from a regular savings account, the same can’t be said for the Tax-Free Savings Account. Because the account is regulated, the deposits are regulated as well and there are contribution limits associated with it. More on this later.
Who is eligible?
To qualify for the TFSA, you need to be a Canadian resident, be at least 18 years of age and have a valid Social Insurance Number (SIN).
According to the CRA, “a person determined to be a non-resident of Canada for income tax purposes can hold a valid SIN and be allowed to open a TFSA, however, any contributions made while a non-resident will be subject to a 1% tax for each month the contribution stays in the account.” For more information see Non-residents of Canada on the CRA website.
What are the contribution limits?
You will accumulate TFSA contribution room for each year, even if you don’t file an income tax return or open a TFSA. So, your contribution room is never lost. these are the contribution limits for the TFSA since its creation:
2009 to 2012 – $5,000 each year
2013: $5,500
2014: $5,500
2015: $10,000
2016: $5,500
2017: $5,500
2018: $5,500
2019: $6,000
2020: $6,000
If you’ve qualified for the TFSA since its inception and have never held one before, you could deposit up to $69, 500 in total contributions.
Each time you deposit funds, it counts as a contribution regardless of the total amount in the account. For example, if you deposit $1,000 and then withdraw it and deposit again in the same year, you are considered to have contributed $2,000.
How to calculate your contributions?
An easy way to check your contribution limits would be to contact the CRA. If you have access to your CRA account online, this process is easy. All you need to do is log in to your CRA account and check the Tax-Free Savings Account section to get the information.
If you don’t have access to your CRA account online you can always give them a call to find out your contribution limits.
Another way of figuring out your contribution limit would be to calculate it yourself. Here is how: what you need to do is add up the limits above for each year after you have turned 18.
For example, if you turned 18 in 2010 then your maximum contribution limit would be $64,500. You reach this amount by adding all of the contributions from the year that you qualified, which is 2010, until you reach the year 2020.
The amount that you come up with is your current maximum contribution limit and you don’t lose this contribution limit. This is the amount that you can deposit in your Tax-Free Savings Account today if you were to open an account and have never contributed before.
Can you withdraw from the TFSA?
The good news is that you can withdraw as much money as you want from your TFSA. However, the amount withdrawn can only be re-contributed into the TFSA in the following year if you have already reached your maximum allowable contributions. Otherwise, you will incur a tax penalty from the Canada Revenue Agency. More on this later.
Example: In May 2020, you opened your first TFSA and contributed your maximum allowable contribution of $69,500. In August 2020, you withdraw $15,000. Because your maximum contribution limit for your TFSA was $69,500 and you already contributed this amount, you cannot deposit any more amount in your TFSA. So, if you were to withdraw $15,000 from your Tax-Free Savings Account, you can only redeposit this amount in your TFSA on January 1st 2021.
You can hold a TFSA at any bank that you want. You can actually hold multiple TFSAs at different banks as long as you don’t go over your maximum allowed contribution limit. It is possible to move your TFSA from one financial institution to the other. However, this process needs to be done right, otherwise you will affect your contribution limit.
By personally withdrawing and re-depositing the amount into a TFSA with another financial institution within the same year, you will trigger an over-contribution if you already reached your maximum allowed contribution and will get a penalty.
To move your TFSA from one financial institution to another, contact the financial institution where you’d like to deposit your TFSA. They will help you fill out the required transfer form (T2033) to move your TFSA to that financial institution. That way, the transfer won’t be considered a withdrawal and a new deposit within the same year so you can avoid penalties.
What happens if you over-contribute?
If at any point you contribute more than your allowable TFSA contribution room, you will be considered to have an over-contribution to your TFSA and you will be subject to a penalty. The penalty is equal to 1% tax on the over-contribution amount in the month, for each month that the excess amount remains in your account.
So, as soon as you realize that you have over-contributed to your TFSA, it’s best to withdraw the over contribution amount to avoid penalties.
What can you invest your TFSA in?
You can hold a wide range of investments in a TFSA, like cash, Guaranteed Investment Certificates (GICs), bonds, stocks and mutual funds.
The pros and cons of the TFSA
The Pros
The pros of the Tax-Free Savings Account are:
- The ability to grow your savings tax free
- The ability to grow your savings much quicker
- Being able to hold a wide variety of investments in your TFSA.
The Cons
The cons of the TFSA are:
- The contribution limits: meaning that you have to watch out for the contributions that you make into the account. Otherwise you will get a penalty which brings me to the second con
- The Over-contribution penalty: You are charged 1% fee for any over contribution.
- The contributions are non-deductible: You can’t declare your contributions when are you doing your taxes to reduce your overall payable income tax.
Bottom line
The Tax-Free Savings Account is a great way to save for any type of goal. The only thing you need to watch out for is the contribution limits. So, make sure you don’t go over your contribution limits and start your savings journey for a better financial stability.
