5 things you need to know about your Tax-Free Savings Account
What to know about tax-free savings

Last month I talked about the 5 things you need to know about your RRSP, so it’s only natural that I follow that up with 5 things you need to know about your Tax-Free Savings Account (TFSA).

Introduced back in 2009, many Canadians have come to love their TFSA, but for some people, the rules that come with this account can be confusing. Generally speaking, TFSAs are easier to understand compared to an RRSP, but that doesn’t mean it’s necessarily better. It’s essential to know the rules for both accounts so you can use them effectively.

If you’re new to TFSAs, here’s what you need to know:

Your contribution room

TFSAs are available to Canadians who are 18 or older. The amount of contribution room you have available depends on the year you were born. As mentioned, TFSAs were created in 2009, so if you turned 18 that year, you’d have a total contribution limit of $69,500 as of 2020. If you weren’t 18 at the time, you’d have to calculate your contribution room based on the calendar year in which you turned 18. The additional contribution room available to you each year is the same for all Canadians and is typically announced by the government in late November or early December.

If you log in to the My Account for Individuals on the Government of Canada website, you’ll be able to see how much contribution room you have available. However, the number you see is not updated in real time, so it’s a good idea to keep track of things on your own.

You can invest in different products

One big misconception about Tax-Free Savings Accounts is that you can only invest in a savings account. This isn’t a surprise considering the name, but it’s still deceiving. While you can certainly put your money in a high-interest savings account within your TFSA, you can also purchase other investment products such as mutual funds, stocks, exchange-traded funds (ETFs), bonds and guaranteed investment certificate (GICs). Think of your TFSA as a vehicle, and the investment products are passengers that go inside it.

Your TFSA is great for different scenarios

If you earn $50,000 or less, investing in your TFSA over your RRSP may be a good choice. The reason you’d want to do this is that you don’t get much of a tax benefit if you invest in your RRSP when you’re in a lower tax bracket. You might be better off saving those contributions for when you earn a higher income. If you’re saving for a major purchase in the short term such as a home, car or vacation, a TFSA is a great place to park your money since you won’t pay taxes on any interest earned. TFSAs are also great for people who have maxed out their RRSP since it’s another savings vehicle that has tax benefits.

Any capital gains are tax-free

Unlike RRSP contributions, you won’t get a tax break when you put money inside your TFSA. However, any gains you make within your TFSA are entirely tax-free. For example, let’s say you invested $20,000 within your TFSA and after 10 years, it grew to $30,000. If you then withdrew that entire $30,000, you would not have to pay any taxes on your capital gains of $10,000. That said, if you use your TFSA to day trade stocks, the Canada Revenue Agency may come after you later for taxes as they may consider your activity as business income.

How withdrawals work

With your TFSA, you can withdraw money at any time, but that money can’t be re-contributed until the following year. For example, let’s say you contributed the limit of $6,000 this year and then you decided to withdraw $4,000 a few months later. You wouldn’t be able to re-contribute that $4,000 until the following calendar year. The only exception to this rule would be if you had contribution room leftover from the previous years, but each contribution would be cumulative. In this case, you would have made a total deposit of $10,000 for the year ($6,000 + $4,000).

TFSAs really aren’t that tricky. Some people prefer them over RRSPs but I like to look at them as complementing vehicles that can help Canadians save money. If you understand the basics of both, you can use them to your advantage.

Barry Choi is a Toronto-based personal finance and travel expert who frequently makes media appearances. His blog Money We Have is one of Canada’s most trusted sources when it comes to money and travel. As a completely self-taught, do-it-yourself investor with no formal training, he makes money easy to understand for all Canadians. His specialties include personal finance, budget travel, millennial money, credit cards, and trending destinations.

Barry Choi is a paid spokesperson of Sonnet Insurance.