The TFSA is turning 10: As contributed by Jeffrey Gregory

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and the contribution limit just rose to $6,000. It’s the perfect time to take a fresh look at the features of this tax-efficient investment vehicle that Canadians are using more than ever.

In March 2008, when the federal finance minister at that time, the late Jim Flaherty, tabled his budget, it included a surprise for Canadian taxpayers: effective the following year, there would be a new vehicle for sheltering their savings from taxes: the TFSA, or tax-free savings account.

Ten years later, statistics show that the TFSA is both very popular and still under-used.

Two pie charts show that there were 13,473,200 TFSA holders in Canada in 2016. However, 41.9% did not make a TFSA contribution and only 10.32% maximized their contributions. These figures come from Statistics Canada.

The TFSA in 5 points

But what exactly is a TFSA? Here is a five-point summary.

 

  • 1. What is a TFSA?
    A TFSA is a savings account that exempts the holder from paying any taxes on the account’s investment income, whether interest, dividends or capital gains. The savings are tax-sheltered as they grow, and withdrawals are also tax-exempt.

 

  • 2. How is a TFSA different from an RRSP?
    A registered retirement savings plan (RRSP) also allows savings to grow in a tax-sheltered environment. However, the two vehicles have different rules, as summarized in the following table. As well, a TFSA allows the investor to make withdrawals and then recontribute the same amounts the following year. An RRSP, on the other hand, imposes a hefty withholding tax on pre-retirement withdrawals unless they are made under the first-time home-buyers’ plan.

 

 

Table summarizing the five main differences between the TFSA and the RRSP. The first point is eligibility. For the TFSA, you must be a citizen aged 18 or over. For the RRSP, you must have earned income. The second point gives contribution limits. The limit for the TFSA is $6,000 as of 2019, and for the RRSP is 18% of the previous year’s earned income. The third point shows that contribution room can be carried forward from year to year in both cases. The fourth point notes whether contributions are deductible. No for the TFSA; yes for the RRSP. The fifth and last point looks at whether withdrawals are taxable. No for the TFSA; yes for the RRSP.

 

  • 3. How much can be invested in a TFSA?
    Annual TFSA contribution limits are the same for every citizen aged 18 and over. Since the inception of the plan, they have varied from $5,000 to $10,000 per year, and were set at $6,000 as of January 1, 2019.    Because TFSA contribution room can be carried forward, the total you are entitled to invest depends on when you turned 18. If you were already 18 in 2009, you are allowed to contribute a grand total of $63,500. Otherwise, use the following table to calculate your contribution room, or consult your personal account on the Canada Revenue Agency website.

 

 

Table showing the annual TFSA contribution room. From 2009 to 2012, it was $5,000. In 2012 and 2013, it was $5,500. In 2015, it was $10,000. From 2016 to 2018, it was back down to $5,500. Finally, for 2019, it is $6,000.

 

  • 4. How do withdrawals work?
    All or part of any contribution may be withdrawn starting in the year following the year it was deposited. As well, each withdrawal frees up an equivalent amount of contribution room in the year following the year it was made. In other words, contribution room is never lost: any amount you withdraw is added to your contribution room for the following year.

 

  • 5. What to watch out for
    The TFSA is subject to stiff tax penalties of 1% per month for any amounts in excess of the available contribution room. So it could be important to pay attention to the timing of withdrawals and contributions: recontributing too soon after making a withdrawal might produce an excess contribution.

 

Strategies for leveraging TFSA use

  • For high-income individuals
    A TFSA could be very useful if you have maximized your RRSP contributions. Essentially, it provides a way of tax-sheltering an additional amount of up to $63,500.
  • For individuals who expect their income to rise
    Some people who anticipate that their income will be considerably higher in future years prefer to put money into a TFSA and allow their RRSP contribution room to accumulate. Once their income has grown, they use amounts from the TFSA to make RRSP contributions, which may result in a more substantial tax deduction than if they had made RRSP contributions when their income was lower.
  • TFSA and RESP
    Lastly, if you would like to save for your children’s future post-secondary education, you would probably favour an RESP due to the significant grants associated with it. However, since RESPs have contribution limits, a TFSA can also be used to help reach to this goal.

To round out this overview and obtain personalized advice about using the TFSA, consult your mutual fund representative or financial security advisor.

 

The following sources were used to prepare this article:

Actualis, “Federal Budget: The new TFSA… and the rest”, March 2008.
Calcul Conversion, “RRSP contribution limit calculator for 2019 on 2018 income”.
Government of Canada, “Tax-Free Savings Account statistics”, 2018 ; “The Tax-Free Savings Account” ; “TFSA: Contributions” ; “Contributions, withdrawals and transfers” ;
Les affaires, “REER ou CELI ? Conseils et astuces”.
Question Retraite, “Cotiser à un REER ou à un CELI ?” ; “Régime enregistré d’épargne-études (REEE)”.

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