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So let’s start with the fundamental question. What is a TFSA? How does a tax free savings account work?
Well, a TFSA or better known as a tax free savings account, allows Canadian residents to put their hard-earned money into an account intended to give them tax-free growth.
There are a variety of tasks that you can purchase. Canadians will have tax-free savings account where they earn a certain amount of interest annually, or others will instead register one with a brokerage and put their investments in the stock markets into this account.
The whole concept behind this type of investment account is to take your after-tax dollars and put them into this account so that you will not be taxed by the time you withdraw them. Obviously, you are taxed initially on your after-tax dollars through your personal income tax returns.
While the initial concepts sound really good, I can attest to it that it is. Of course, it does come with its downsides which we will discuss later throughout this post. However many of your friends or family members you ask, I’m sure most of them will say their favorites investment or savings account is this one right here.
Minimum age for TFSA:
So there is a minimum age requirement in Canada to be able to open a tax-free savings account. The minimum age is 18. In fact, generally, you are required to be of that age and have a social identification number (SIN) to open one of these types of accounts,
Benefits of Tax-Free Savings Accounts:
So, what are the prescribed benefits of opening a tax-free savings account? The most significant advantage of holding a TFSA is that your investments or interest over time are earned tax-free.
Whatever you can contribute to your TFSA and earn, you can withdraw without any penalty or fee. Of course, there may be a fee to sell stocks, bonds, ETFs, mutual funds, or any other public security, but that mainly comes from the broker or financial institution themselves.
Look at this beautiful piece of art:
Another massive benefit is that any unused TFSA contribution room from previous years can be carried forward. As you will see in a different section below, once you turn 18, any unused contribution room accumulates and will always be carried forward.
So if you turn 22, for example, and you decide that at this age you want to start investing in a tax-free savings account, you will be able to use the contribution amounts from age 18 until the current moment to contribute with.
A further example is shown below, where we calculate the amount of TFSA contribution room you may have.
I would also state that another benefit of a TFSA is it’s easy to use and convenient. Withholding and registering a tax-free savings account, you don’t necessarily need to worry about the amount of contribution room you need to calculate. Every year there is an annual dollar limit (TFSA dollar limit) to your tax-free savings account.
Well, this is very simple to understand. It’s convenient, and its ease of use is understood more when we compare it to an RRSP. At the time of this writing, I’m working on my RRSP guide. So allow me to just state that the RRSP is calculated based on your earned income. Therefore it makes it a little bit more challenging to track all the income you’ve made or your tax returns you might have misplaced to understand the amount of money you can contribute to this registered account.
Lastly, another benefit of holding a tax-free savings account is that it will likely be the only investment account you need. I know not everyone’s going to have more than $6,000 to invest with every calendar year. That way, if you only have half the amounts or any amount in between the annual threshold, you are able to continuously contribute to this account. There are also no minimum requirements that state you need to constantly hold and deposit a certain amount of money every year.
Disadvantages of a TFSA:
So although a TFSA seems good initially, we could talk about some of the downsides to holding this type of account.
One of the disadvantages of owning a TFSA is the fact that it’s not tax-deductible. Because you are using your after-tax dollars to contribute to this account, you are not eligible to claim your contributions to this account on your personal income tax returns. If you were to instead on an RRSP, you would be able to claim such contributions on your personal income tax and therefore have to pay less in taxes for the year.
Another disadvantage I would say is the contribution room. If you are an individual who has, let’s say, for example, $10,000 or more to invest yearly, then it’s you’re going to be left with some excess to invest in. As well that access compared to the contribution room of the TFSA yearly probably will be taxed.
I know the situation doesn’t apply to everyone, which is understandable. However, it’s for those with a budgeted amount of money for investments more significant than the yearly contribution room of a TFSA that will have to look for other assets where they could potentially receive tax-free earnings.
Lastly, any U.S. based dividends are subject to a 15% withholding tax. Yeah you heard me, 15%! It’s a rule regulated by the Canadian government, where if you own any stocks or ETFs based in the U.S. for example, there is this 15% tax in place.
The most common way to avoid paying this 15% is to either invest in Canadian public securities (which is likely why there is a 15% tax) or to open an RRSP and invest in U.S. based securities. There is no withholding tax for U.S. based dividends in that account. However, you will be paying tax during withdrawals so who’s the big winner here?
Is a TFSA a registered account?
Yes, from what I know, a tax-free savings account is a registered account. This is because you are needing a social identification number to be able to open this type of account in the first place. The account is registered with the Government of Canada and registered and maintained with the brokerage or financial institution you choose to open it with.
And ultimately allows the Government to understand the amounts you have contributed into your tax-free savings account along with other accounts such as an RRSP. All to ensure that if you are going to withdraw any amount from your TFSA, you won’t be flagged for suspicious activity by the Canada Revenue Agency if you decide to deposit any large sum of money into your bank account, for example.
Can International Students open and contribute to a TFSA in Canada?
Yes. If you are an international student studying in Canada, you can open up a TFSA. The minimum requirements for any Canadian to be eligible to open a TFSA are the same for those from abroad or those considered non-residents. You must have a valid social insurance number (SIN) and be at least 18 to open a tax-free savings account.
I had to do some research into any “buts” for these international students. The truth is, if you’re a non-resident, you can open a TFSA, but for any contributions, you may carry a monthly 1% tax on those contributions.
So let me break it down a little further.
Here was Serge, a non-resident in Canada, who decided, during January of 2021, to contribute $6,000, the annual TFSA contribution limit.
He holds this amount for the entirety of the year.
The total amount of tax he will pay is $720. We take the $6,000 contribution and multiply it by the 1% tax for each month, and then the whole months the contributions are held into the account ($6,000 x 1% x 12 months).
If it wasn’t made clear, any non-resident of Canada can open a TFSA as long as they are 18 and have a SIN. For more information, please consult the Government of Canada’s website.
How much Money Can I have in my TFSA?
No set lifetime limit is placed on owning a TFSA. So you’re not necessarily capped at $100,000 holdings into your account for an example.
You are more than welcome to contribute and hold as much as you want into a TFSA within reason. Since you don’t owe any taxes on the income earned in your TFSA, there’s no need to make sudden withdrawals due to any set limits you’re able to keep in that type of account.
While this sounds great, there, of course, is a catch. There is a yearly limit you can contribute to your TFSA, which I will describe below.
How Much Can I Contribute to my TFSA?
Now comes to answer a critical question. I’m sure if you’ve heard of a TFSA or have read the above information, you really are wondering how much you can contribute to it.
First, we need to discuss an annual limit that you can contribute to your TFSA. I’ve eluded to such fact in my writing this far yet have not actually touched upon it directly.
Every year, the Canadian government sets an annual limit to TFSA’s. For this most recent year, 2021, the yearly limit is $6,000. In some cases, this means that you can contribute up to a maximum of $6,000.
If you contribute more than the annual limit, you may be subject to an overcontribution penalty; we will discuss that more in a moment.
However, there are rules in place where if you have not previously contributed the annual limit, you can carry forward the uncontributed amount into future years.
Is that a little confusing? Let me illustrate an example to you.
We have our pal Serge here.
When he turned 18 in 2018, he was getting ready to graduate from high school and ensure he gained admission to a post-secondary school. Investing was the last thing on his mind.
Fast track to 2021, where Serge has graduated from university with a degree in stonks; it was finally time to open a TFSA and start investing for the future.
Serge turned 18 in 2018, meaning he could open a TFSA at that time and begin contributing. During 2018, the annual limit was $5,500. Since he did not contribute any amount, he can carry forward the entire $5,500 for future years.
During 2019 and 2020, the annual limit was $6,000, which is also carried forward for following years.
As of 2021, the annual limit is also $6,000.
Together, Serge has a total contribution room in 2021 of $23,500. As we know, this means Serge can contribute a total of $23,500 into his TFSA without suffering any penalty and taxes.
I hope that simplifies how the contribution room works. But let’s look at another example to further illustrate the point being made.
All of the background information we know about Serge is mostly the same. However, the most significant difference is that during 2018, when he turned 18, he decided to open up a TFSA and start learning to invest.
Serge made some contributions to his TFSA over the years:
In 2018, he contributed $500 from his graduation money into stocks.
In 2019, he found $100 on the side of the street and decided to contribute this amount into some bonds.
For 2021, Serge contributes $1,000 into his TFSA to purchase ETFs after having read Beating the Street by Peter Lynch
In total, his contributions over the four years are $1,600
Since we know what his total contribution room is as described above ($23,500), we will take this contribution room and subtract it by the contributions made over the four years. The calculation will allow us to analyze the amount of leftover space for Serge to contribute to.
Therefore, $23,500 – $1,600 is equal to $21,900.
Serge can now contribute an additional $21,900 to his tax-free savings account.
How much TFSA room do I have?
You’re probably asking yourself, “How much can I put into a TFSA?”
Start with the year you turned 18 and add up all the annual contribution limits/room each year until this current year. If you’ve made any contributions since you turned 18, add up the total amount of these contributions or, at the very least, attempt to guess.
You will then subtract the total annual contribution room given for each year by the number of contributions you have made since 18.
It should be a simple calculation but if you need any further explanations, let me know below in the comments.
For a complete list of the annual limits set by the Canadian Government since 2009, click here.
What If I Overcontribute to a TFSA?
If you happen to overcontribute to your TFSA, then there is a penalty. The penalty is calculated as 1% of your overcontribution, and you are charged monthly if this overcontribution remains in the account.
So, for example, if your overcontribution to your TFSA is $500, you would owe $5 each month ($500 x 1%). Let’s say it stays in your account for 6 months. Well, then you would owe the CRA $30 in total from this penalty.
If you mistakenly overcontributed and didn’t realize it, you will be contacted by the CRA, likely by mail, with a statement regarding your overcontribution. There likely is a form you will need to fill out regarding paying back the overcontribution.
The best thing to do in this situation is obviously not ducking the CRA. You don’t want to do that. Instead, fill out any paperwork they require, contact them as needed, and of course, withdraw the amount from your account.
Overcontributions happen sometimes, and it isn’t the end of the world. Just make sure you get what’s done to save yourself money and stay out of trouble.
Transferring TFSA from one bank to another:
FYI you can transfer your TFSA from one bank or broker to another. Each broker or financial institution may have its own guidelines and standards, so I recommend you visit their websites or talk to their representatives to find out more.
However, I will be basing this off of Wealthsimple’s own guidelines as I do like their platform and use them myself. I am not affiliated with Wealthsimple, although if they want to sponsor me, Wealthsimple, let’s get in touch.
To remain on track, the first thing you will want is to download a statement from your TFSA. If you’re planning to transfer to Wealthsimple, they will ask for your statement so they can review it and your information. This will help them get things ready and put your information into their system before transferring your account.
As a bit of common sense, ensure that your information is up to date with your current bank, as it could affect the length it takes to transfer from one to another.
You can also choose how much you want to transfer. Wealthsimple recommends that you move your entire account as cash, which means that your previous broker or institution will sell all the holdings in your account so that just money is transferred.
However, you can, of course, transfer your holdings or only part of the cash in your account, depending on your preferences. You won’t face any tax consequences due to selling your holdings because it’s a TFSA.
If you haven’t done this already, the last step is to create an account with the desired broker or institution you want to use. Then from there, you will be able to select an option to transfer a statement, in which you can enter in the correct details, such as an account number, an estimated value of the account, and a signature for the request.
After this, it will likely take some time for the process to be approved, so you’ll want to keep an eye out and stay in touch with both institutions or brokers regarding this process.
Can You Have more than one TFSA?
Yeah, just as you can have multiple chequing or savings accounts with other banks and financial institutions, you can hold and contribute to multiple tax free savings accounts.
However, it should be especially noted that your contribution room does not increase or multiply by the number of TFSAs you have. If that were the case, we all would be throwing our money into them with no repercussion, and there would be less tax revenue going to the Government.
But what is the motive behind having more than one TFSA?
I would say the motive behind it is to be more organized and primarily to fund different things.
For example, someone may have a TFSA dedicated for retirement, another for travel, and another for a lifelong dream achievement, such as purchasing a luxurious car like a Ferrari.
By holding different accounts for these other objectives, people can clearly keep track of the contributions they make to these goals and better measure their results.
Personally, I don’t think it’s a terrible idea to operate multiple TFSAs for these reasons alone. However, you will likely incur more fees through trading securities or for management fees when you pay your account/investment managers a fee to manage your investments. At the same time, the management fees you may incur would be the same regardless if you had planned to invest in the same amount.
If you are just looking to invest for retirement, for increased wealth, or don’t care about holding different TFSAs, it’s probably much better for you to own a single TFSA.
However, do as you please and consult a financial advisor for any investment advice. I am not one.
Is a TFSA Tax Deductible?
The simple answer here is no. It is not tax-deductible. This is because you are using your after-tax dollars to contribute funds to this type of account. You have already been taxed on your money.
If this were instead an RRSP, where you could deduct the contributions on your personal income tax, it would be a much different story. Alas, it isn’t.
Reporting your TFSA Contributions on Tax Returns:
Because your contributions aren’t deductible, you do not need to report them on your tax returns. Any income earned is tax-free. So rest easy knowing that you do not need to scramble to get your total capital gains earned, dividends, and other income calculated to report on your tax claims.
How To Withdraw Your Money from a TFSA:
It generally is quite simple. If you are holding some sort of public security in your investment account, the first thing you will need to do is sell it.
Then whenever you have sold the public security or securities, you can go ahead and withdraw the funds from your TFSA.
Generally, you may have different options to acquire the funds. It may be through a money transfer into your bank. That’s why it’s always beneficial to check the other payment options your broker or institution offers.
What Happens When I Withdraw from my TFSA?
Well, traditionally, you will receive money in your bank account. However, to be a little more specific, you will ideally dispose (or sell) of your positions in securities, whether they be stocks, bonds, ETFs, etc. Then any amount in your account that is available to trade, you can withdraw to your bank account.
If, instead, you have a TFSA that pays you a certain amount of interest monthly or yearly, you would just withdraw any of the available amounts into your TFSA.
So when you withdraw from your TFSA in the same year as you made contributions, you CANNOT get that contribution room back.
Let’s again look at an example to fully understand this lesson.
Serge has contributed $5,000 of the $6,000 annual limit into his TFSA. During that same July, he sees an ice cream store for sale. The asking price is $3,500. Therefore, Serge withdraws the appropriate amount from his TFSA and purchases the store.
During that September, Serge has earned the $3,500 back in profits from the store and decides to reinvest it into his TFSA. He puts this total amount into the account.
However, since Serge only has $1,000 of contribution left for the year ($6,000 – $5,000), he will overcontribute $2,500. As we know in an earlier section, there’s a 1% monthly tax for however long the overcontributed amount remains in the account.
While you may not always withdraw from your TFSA in a year, it nonetheless is essential to know so you can avoid paying tax on this account at all costs.
Is a TFSA actually worth it?
To me, this is a no-brainer. The answer is yes. Listen, the main reason it is worth it is that any income you earn through this account is tax-free.
There are not many other investments that will generate your tax-free returns. Even if there are, they are not as easily accessible as opening a TFSA is.
But you know, contributing to a TFSA goes a long way. It can teach us to be serious about our personal finances and ensure we invest the funds. It’s the reward that motivates us. It’s our goals that we contribute to that make investing worthwhile.
Many people use a TFSA to one day build generational wealth, to be able to retire fast and early, to see the world whenever it’s time to call it quits at your day job. A TFSA can represent many possibilities for you because of its advantages.
It’s always good to invest in this account with a set objective. Maybe you have to find out what that objective is. I encourage you to figure out what do you want to invest in? And of course, what are you doing to do with those funds?
Even investing is much more than just simply contributing to an account every month. Working a 9-5 so you can set aside 10% of your weekly income to your TFSA.
Every dollar you invest gets you that much is closer to any goal you set out to accomplish. With every dollar, you’re investing into your future.
A TFSA can represent the future. It can symbolize your future.
So yes, to me, it’ll always be worth it.
Plus who even wants to pay taxes? No one, that’s the answer!
What’s the best way to use a TFSA?
I’m sure you can go online and find various investing strategies to apply to your TFSA. Of course, be responsible and, as always, do your own research and seek the advice of a financial advisor for any financial decisions.
Does anyone get sick and tired of hearing that?
Anyways, I think one of the best ways to use a TFSA is to start contributing to it when you’re young. This will give you the chance to earn more money over time. So ideally, when you’re in your 20’s or 30’s. You start setting aside a considerable amount of money from your income and start investing in it.
It’ll give you the chance to effectively use the power of time on your side. It’s called the time power of money, and I will explain more in a future article.
But just understand that your money is worth more now than it will be in the future. So whatever you invest in today will hypothetically be worth more in the future.
As well, understand what you’re objective or ultimate goal is with your TFSA. If you can know what you’re trying to do with the money you earn, then you can start setting up a plan that will allow you to achieve that within a set amount of time.
It may be brief, but in all honesty, it’s just a matter of starting at any age if you haven’t previously contributed. Setting aside even $10 a week can make a difference in the long term.
Not everyone has thousands of dollars to invest. I understand that. But as we say to a variety of things, any contribution, big or small, goes a long way.
And investing in a TFSA is no different.
So if you’re looking for ideas on what you should invest in and what investment styles you should use, there are a couple different ones.
You could always pay someone to invest for you. We call these portfolio managers/investment managers/financial advisors. They have a variety of names.
However, you may just want someone to do the work for you to enjoy more of life or focus on other essential things. There’s also Robo advising with Wealthsimple, where the system will invest a certain amount per month and it will manage your portfolio for you.
Either option is great, but understand there is a fee associated with having someone or something managing your portfolio. So if you’re okay with that and want to save some time, it could be an option for you.
Maybe you want to be very active with your investing. Choosing the different stocks, bonds, or ETFs (exchange traded funds) to invest in. Hey maybe you fancy guaranteed investment certificates. For that, I would recommend reading The Intelligent Investor by Benjamin Graham.
That book is considerably old, but its strategies have been used, and many people still attest to it. I’m reading it currently and am enjoying it immensely.
The Intelligent Investor teaches you about investing and how to choose stocks. That’s a very brief description of the book, but you can always check it out using the link above for reviews and more information. I will be doing a review on it whenever I have finished reading it.
If you want to be a little more passive but still select the types of ETFs you purchase, I might recommend Peter Lynch’s Beating the Street.
It’s a book designed to teach you why index fund investing (or investing in ETFs) can often outperform the returns earned by professional portfolio managers and even Wall Street.
It will be another book I shall read soon, and of course, I will review it.
Of course, there are various other selections to choose from, so do some research and even see what legendary investors have read. To know how to be the best, sometimes you have to learn from the best.
The Best Tax-Free Savings Account in Canada:
I haven’t looked at every TFSA account offered across the country, so it’s tough for me to say which is the best.
However, you can check out the accounts review section of the website. It is where I do a review of TFSA accounts and much more.
For a high-interest rate TFSA account, the Canadian Bank offers a good account with minimal fees and probably one of the highest interest rates offered by anyone in Canada.
I use the Wealthsimple Trade TFSA account, where you pay $0 in commissions on your trades, and you can purchase public securities listed on Canadian and U.S. exchanges. $0 commissions are very enticing, but I would also encourage you to do some research into it.
As well, do additional research into any TFSA account you hear from influencers, blog posts like mine, or through references via colleagues or friends. It never hurts to truly determine if what someone is saying is all that glitters in gold.
I hope you found a ton of value in reading this article. I definitely have enjoyed sharing with you what I know and what I’ve learned about TFSAs in this article.
Whether you want to have an extra income when you get older instead of relying on your pension income or a guaranteed income supplement, a TFSA is something I think everyone should consider opening.
But please don’t carelessly deposit money into the TFSA with Mom or Dad’s credit cards. That is a disaster waiting to happen. What happens if you lose all that money in stock trading?
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