Tax-Free Savings Account (TFSA): An In-Depth Guide

Learn the basics of a Tax-Free Savings Account (TFSA), and whether it’s the right option for reaching your personal finance goals. Check out our guide.

Tax-Free Savings Account (TFSA): An In-Depth Guide

Do you live in Canada and want to save money? If so, one of the best ways to do so is to open a TFSA (tax-free savings account).

First things first: what is a TFSA? As the name implies, it’s a type of account that doesn’t apply taxes on any of your contributions. As such, it’s a great way to protect both your immediate and long-term financial outlook.

Not sure whether opening a TFSA is the right choice for you? Read on to find out everything about these accounts and their benefits!

How a TFSA Works

The Government of Canada introduced the TFSA in 2009. Its purpose was to allow Canadians to save money tax-free throughout their lifetime.

To open a TFSA, you must be a Canadian resident at least 18 years old. You also need a valid social insurance number (SIN). You can open a TFSA account with any local financial institution or issuer.

While it’s referred to as a savings account, a TFSA allows you to store many financial instruments. These include cash, bonds, stocks, mutual funds, guaranteed investment certificates, etc.

Why Open a TFSA?

The main incentive to open a TFSA is to set money aside without your withdrawals getting taxed.

Let’s say you invest $5,000 into a TFSA, and your friend invests $5,000 into a standard account. With a 10% TOI, you can both withdraw $5,500. However, you’ll withdraw $5,500 without tax, and they’ll get taxed on the $500 gain.

Being a TFSA holder also gives you more flexibility. For instance, you can withdraw funds for any purpose while adding money back into your account. That said, it’s best to do so during the following tax year.

TFSA also doesn’t involve any mandatory withdrawals. In theory, that allows you to leave your funds to grow for life. If you choose a successor to your account, they’ll get your funds without impacting their TFSA.

The only downside of a TFSA is that it’s not protected from creditors. If you’re facing bankruptcy, any assets or funds in your TFSA are fair game. In these situations, other financial products may be a better option.

Long-Term Benefits

Want to know how much of an impact opening a TFSA will make? Here are the potential benefits compared to non-registered investment accounts.

  • Over five years: $1,750
  • Ten years: $7,500
  • Fifteen years: $19,500
  • Twenty years: $40,750

As you can see, TFSAs can offer a decent financial boost even in the short term. Still, you’ll get more bang for the buck if you open the account at an earlier age and develop a long-term investment strategy.

Contribution Limits

When you contribute to a TFSA, the CRA charges a tax for each month that the money remains in the account. So, how much should you deposit?

To answer that, we need to look at the annual TFSA contribution limit. When the TFSAs were first introduced, this limit was $5,000. Over the years, it kept rising until reaching the current $6,000 limit in 2019.

If you don’t reach the annual TFSA limit, you’ll increase your limit for next year. Making withdrawals also increases next year’s limit. For example, withdrawing $1,000 in 2022 allows you to deposit $7,000 in 2023.

It’s worth noting that there aren’t any lifetime limits for TFSA holders. When you combine that with the fact that you can re-contribute any funds you withdraw from a TFSA, it’s easy to see why these accounts are so popular.

You can also hold multiple TFSAs, but you’ll need to watch your contributions. If you deposit $4,000 into the first TFSA, you can only deposit $2,000 to the second one. Otherwise, those contributions will get taxed 1% per month.

TFSA vs RRSP

Looking into a potential substitute or supplement to your TFSA? If so, an RRSP (registered retirement savings plan) may be a good choice.

Financially speaking, these two accounts are the exact opposites. A TFSA doesn’t tax your withdrawals, but the RRSP does. By comparison, RRSP deposits are tax-deductible, whereas TFSA ones aren’t.

By understanding how these accounts work, you can build a better tax-saving strategy. For best results, you should use both products while considering other items to diversify your portfolio.

How to Open a TFSA

Now that you know why opening a TFSA is a good idea, how do you do it? In truth, this process is quite straightforward.

First, find a financial issuer that offers TFSAs and submit your application. Provide all the necessary documentation to see if you qualify. If you do, complete the consultation either online, in person, or over the phone.

There are only a few things to keep in mind here. First, make sure to avoid any errors during your application. That could invalidate the TFSA and cause your capital growth to get taxed as with any other investment account.

Also, decide whether you want to have a self-directed TFSA. That means you’d manage your investments yourself instead of having your issuer do it. Discuss this with the issuer before opening your account.

Other Information

By now, you should have a solid grasp of how TFSAs work. That said, there are still a few important factors we need to go over.

In some provinces, for instance, the minimum age for opening a TFSA is 19. Also, only an individual applicant can open a TFSA for personal matters. These types of accounts aren’t open to joint applicants.

You can transfer TFSA withdrawals to someone else. You’ll need a Common-Law Partnership or Breakdown of Marriage form. You can also contribute to a spouse’s TFSA without impacting your contribution limits.

Finally, TFSAs are only available to Canadian residents that meet the age requirements. If you lose your resident status, you’ll be able to access your account, but making further deposits will be a no-go.

Open a TFSA Today!

For Canadian residents, opening a TFSA is almost a no-brainer. As long as you don’t go over your contribution limit, a TFSA will make a positive impact on your finances

Still not convinced whether you should open a TFSA? We can help you reach the right decision and develop the perfect savings strategy! Contact us here to learn more about what we can do for you.

Tim Belanger
About Tim Belanger

Tim Belanger is a local Ottawa Mortgage and Insurance broker that prioritizes you. No matter your lifestyle or budget there is a plan for you.