Ah, 2022. As with any new year, it is a refresh on all our goals, dreams, and aspirations. For many of us, we want to make a difference in our financial situation. Maybe we would like to make more money, invest, or even save. Having basic financial literacy will help us navigate our goals and make smarter decisions this year.
So, what tool will help us grow our money, dare we say, tax-free? This article will talk about the Tax-Free Savings Account (TFSA) and everything you need to know to make the most of your 2022.
What is a TFSA?
The TFSA is simply a registered savings account that allows Canadians 18 or older to withdraw, contribute, and make investments within the account, tax free.
Introduced by the federal government in 2009, the TFSA account was designed to have eligible individuals better reach their savings goals by setting money aside throughout their lifetime.
Let’s get one thing straight – while technically a savings account, the TFSA, in the eyes of many financial professionals, is incorrectly named. It should be named the Tax-Free Investment Account as you can earn interest, dividends, and capital gains tax-free inside the TFSA. Think we can get a good word in with Mr. Trudeau?
How TFSA Contribution room works
While the TFSA allows you to earn within the account tax-free, there are limits to the amount of money you can place in your TFSA each year. This should not be confused with what you can earn once your money is invested. There are no limits to growth within your TFSA, making it an excellent wealth-building tool.
The graphic below gives an account of the TFSA contribution room over the past 14 years:
TFSA contribution limit by year
|Year||TFSA Contribution Room|
The TFSA contribution limit in 2023 is $6,500. What is wonderful about the contribution room is that any unused room gets carried forward into the new year. Therefore, you could have a TFSA max contribution limit of $88,000 since the account started if you have never contributed in your life before and met the eligibility criteria during that time. The basic TFSA eligibility is as follows:
- You have been 18 or older in 2009
- You carry a valid SIN number
- you are a resident of Canada
You must know your TFSA contribution limit and avoid going over it within the following calendar year, generally January 1st. Over contribution can have some significant financial penalties. Every month you over contribute to your TFSA account, you pay a 1% fee per month. For example, if you spent $3,000 in over contributions, you would pay $30 every month the excess amount stays in your account.
To find out more about your TFSA contribution room, you can visit the CRA website and log into your account for more information. Alternatively, you can give them a call at 1-800-267-6999.
You can open a CELI through your institution. For example, with EQ Bank, you could earn 3% interest on your deposit!
TFSA withdrawals can be made at any time in the year. When you withdraw funds from your TFSA, it does not reduce the number of contributions you have made for the year. The amount you withdraw can be put back in your Tax-Free Savings Account contribution room at the beginning of the following year.
Remember: You need to know how much contribution room you have available. If you decide to allocate your withdrawn funds back into your TFSA, you can re-contribute only if there is enough room available. Otherwise, you will be subject to the 1% tax on any excess amount.
Investing with your TFSA
As a registered account, there is a range of different investment types that you can hold in your TFSA. Some TFSA eligible investments include:
- Guaranteed Investment Certificates
- Exchange-traded funds
- Mutual funds
When you decide to open a TFSA, these investments should align with your financial goals and risk tolerance. Depending on your knowledge and financial literacy level, you may use self-directed TFSA or have an advisor.
A self-directed TFSA is beneficial to the informed and confident investor. You minimize fees incurred on your account, have far more control and can see some incredible gains over the lifetime of your investment. In short, you are not limited in your holdings, and the growth of your account is truly unlimited.
Challenges: With great power comes great responsibility. Self-directed TFSA’s do have to incur the losses. Managing your portfolio will be 100% your responsibility. This is not to say that you shouldn’t do it, but it is essential to know the risks before jumping into it.
The name of the game is time in the market, not timing the market! So follow your investments, research and be sure to change course if need be.
If you believe in taking the passive approach to investing, you may consider having an advisor handle the investments within your TFSA account. You can do this through a brokerage, bank, or a robo-advisor like Wealth Simple to manage your Tax-Free Savings Account. The benefit of this option is that you are not looking at the day-to-day that may come with this type of account. If you are investing for the long-term, this can be a profitable strategy while working on some of your other financial goals.
Challenges: There is a fee associated with having other people manage your accounts and investments. Canada’s average management expense ratio fees (MER) are roughly around 2.23-2.53%. So, imagine making a 12% gain on your investments. When the MER is included, you would be looking at a roughly 9% return when it is all said and done.
When would you pay taxes on a TFSA?
You may be asking yourself, “I thought the TFSA was tax-free. Why would this section be important or relevant?” Unfortunately, friends, there are instances in which a TFSA holder may incur taxes.
For the most part, investments made within the TFSA are not subject to tax- either while held in the account or withdrawn. The first instance of taxation has been discussed already. When you over contribute to your TFSA, you will incur a 1% tax on any over contributions.
Another instance that will require you to pay taxes is non-resident contributions. For instance, if you made contributions as a non-resident of Canada, you will be subject to 1% tax-per month on these contributions.
The difference between this tax and the tax of a Canadian resident over contributing is that a withdrawal of any excess amount over your contribution limit can reduce the tax payable, whereas, in the case of the non-resident, the total amount of non-resident contributions must be withdrawn for the tax to no longer apply.
To learn more about taxes on the Tax-Free Savings Account, visit the Government of Canada website.
TFSA Life Events
As uncomfortable as it may be, in the event of your untimely passing, some things must be considered when it comes to your TFSA account. Note: tax implications may vary depending on the following:
- TFSA type
- The type of beneficiary(ies)
- Income earned after death
- How long amounts are given to beneficiaries after death of the TFSA holder
If a TFSA holder passes on and leaves a beneficiary, the TFSA will go directly to the beneficiary in name. This could be common-law, spouse, children, or family members. If, after death, any income is earned within the account, it will be protected from any tax earned, and function as a TFSA is designed to function.
Possible taxation may arise if there is an excess TFSA amount in the deceased holder’s TFSA. The excess amount will be subject to the 1% tax per month.
To learn more about taxation of the TFSA upon death, visit the Government of Canada’s webpage.
Sharing a TFSA account with a spouse or common-law partner
A common question people have is “Can I have a joint TFSA”. Unfortunately, the TFSA can only be opened by one person. You can, however, work with alternatives that can act as a “joint TFSA” in certain respects. Some options include:
1. Designate your spouse or common-law partner as a beneficiary
Not only is this avoiding unnecessary administrative hassles upon your passing, but you can also transfer your TFSA to your spouse or common-law partner when they are listed as a successor holder.
2. Give them money
If your spouse or common-law partner has not used their contribution amount, you can give them money to take full advantage of this financial vehicle. Teamwork makes the dream work!
If you meet the eligibility criteria, you can open a Tax-Free Savings Account at virtually any financial institution within Canada. So you can get your 2022 started on the right foot from banks to online platforms. The best part is that there is no limit to how many TFSA’s you can open; just sign up and avoid going over your contribution limits.
Will you make that change today? Let us know in the Facebook Group!