What is a TFSA and how should I use it?
By Salma Garde 8 February 2019 5 min read
What is a TFSA?
A Tax-Free Savings Account (TFSA) allows you to grow your savings tax free. Every Canadian resident that is 18 years of age or older is eligible to save or invest each year in a TFSA.
The TFSA could include investment products like mutual funds, bonds, stocks and GICs. The income earned on these investments, as well as capital gains, is not taxed. Ever. Plus, unlike RRSPs, there are no deadlines for your annual contributions.
“The biggest advantage of a TFSA is that it’s truly tax free,” said Salma Garde, Senior Financial Advisor, ATB Wealth. “Your contribution is made from your after-tax income, the growth in that account is tax free for the rest of your living life.”
How much can I contribute?
The federal government instituted TFSAs in 2009 and each year they set a contribution limit. This year's contribution limit is $6,000. "If you have been a resident of Canada over the age of 18 since 2009 and have never contributed to a TFSA, you have $63,500 of contribution room in this tax-free savings product," said Garde. "Even if you haven't contributed in the past few years, you can carry all that unused contribution room over."
How can I use a TFSA?
TFSAs are a multi-use savings product and can be used to help you reach a wide range of financial goals. You can use a TFSA to save up for a car, a wedding or a holiday, but they can be most advantageous as an addition to your retirement savings portfolio.
Here are three ways a TFSA can benefit your retirement income:
Tax free supplemental income.
“TFSAs are a very useful tool for retirement. This is because all your other sources of retirement income, like RRSPs, CPPs and Old Age Pension, are all income sources that you will have to pay taxes on. You can always pull money out of your TFSA in retirement completely tax free if you need supplemental income,” said Garde.
In retirement, you might need extra funds to go on a special holiday, renovate your home or put a down payment on a recreational property. Using money in a TFSA allows you to fulfil those needs without any taxable impact.
You can replace the funds, at the full amount including growth.
“Another advantage is that when you pull it out of the TFSA, you can always replace the funds to the full amount without losing that contribution room. This allows you to rebuild the fund from your cash savings, up to the full amount and including any growth you’ve earned in the TFSA,” explained Garde.
Withdrawals that you make are added back to your contribution room in the year following the year of the withdrawal. So if you’ve accessed all your room, you will have to wait until the next calendar year to replace what you’ve taken out.
Money will remain tax free, even if transferred to the other spouse.
If you and your spouse both have RRSPs, and you pass away, your spouse will be the beneficiary of that RRSP. When they withdraw from that RRSP, they will have to pay taxes on it. With a TFSA, the beneficiary spouse can transfer the funds to his or her TFSA and keep the tax-free status.
“Imagine having a maxed-out TFSA of $63,000 times two. That $126,000 will always remain tax free, even when the TFSA is paid to a beneficiary after death,” said Garde.
When is a TFSA not a good idea?
TFSAs are great for reaching savings goals, but should not be used as a routine savings account. You should have a plan for that money, such as saving for a car, a down payment on a house, an emergency fund or as part of your retirement portfolio.
“You shouldn’t use it like a regular savings account that you make transfers from, back and forth, to your chequing account. It should be used for savings that doesn’t have a lot of movement going in and out of it,” said Garde.
One reason for this is that it can become difficult to track what you’re putting into it. Contributions are limited year-by-year, and if you’re not keeping track you could be penalized for over contributing.
Your TFSA should be used for a specific purpose and its tax-free growth can really help you achieve those savings goals. If you’re using it to meet your day-to-day banking needs, it will not serve its purpose and you won’t benefit from it.
Should I contribute to a TFSA or RRSP or both?
Where your contributions should go really depend on your very specific financial situation and savings goals.
Investing with a low income.
“If you earn $30,000 a year and can put $5,000 of that into an RRSP, you will still get a tax refund for that contribution.” Garde continued, “Then you can take the money you get in your tax refund and put it into a TFSA. In this case, the money you’d save on taxes in a TFSA would be very little, so the RRSP might be the better choice.”
If you want to save while you’re a student, a good option would be to put your money in a TFSA. This is because your income is typically lower, and any tuition tax credits will bring you below taxable income. Contributing to an RRSP won’t give you a tax break.
“Later, when you start your career and you’re earning a higher income, you can take the savings out of your TFSA and move them into a RRSP. Then take the tax deduction you might get back from contributing to the RRSP and put it towards rebuilding your tax-free savings,” said Garde.
Investing with a high income.
High income earners will typically benefit more from contributing to their RRSPs. Because they are in a much higher tax bracket, the tax savings of RRSP contributions will outweigh any growth in a TFSA.
“A high-income earner can max out their contributions in their RRSPs, but if they receive a tax refund, they can use that to build their TFSA. It is always advantageous to have a TFSA in retirement to use for supplemental income,” said Garde.
A TFSA could be a beneficial savings tool for most people and can help you reach a range of savings goals, including retirement. If you don’t have one yet, it’s not too late to start saving.
“Everyone should cash in on this. Even if you’re contributing a small amount, the more time you have it in the market, the larger compounded return you’ll get in the long run.” Garde continued, “You can build a sizable savings and it’s a huge compliment to your retirement portfolio.”
For more information and to open a TFSA, contact an ATB Advisor or visit ATB Prosper.
ATB Wealth consists of a range of financial services provided by ATB Financial and certain of its subsidiaries. ATB Investment Management Inc., ATB Securities Inc., and ATB Insurance Advisors Inc. are individually licensed users of the registered trade name ATB Wealth. ATB Securities Inc. is a member of the Canadian Investor Protection Fund and Investment Industry Regulatory Organization of Canada.