The Investing Series: Tax-Free Savings Accounts (TFSA) Canada

Basically, the Tax-Free Savings Account (TFSA) in Canada is the equivalent of the Roth IRA in the U.S.

YOUR ELIGIBILITY

You have to be 18 or older and a resident of Canada

No income requirements or limits.

HISTORY

It started in 2009, and Canadians can put in about $5000 a year from their net income to grow, tax-free even when they decide to take it out. It’s been really popular since then, and for 2013, they’ve increased the TFSA contribution amount to $5500.

Here’s an example of the past 6 years:

• 2009: $5000
• 2010: $5000
• 2011: $5000
• 2012: $5000
• 2013: $5500
• 2014: $5500

WHY I LIKE THE TFSA

Why I REALLY like the TFSA is because I can put money into it after I’ve been taxed on my income, it grows tax-free and even when I take the money out, it’s tax-free.

It’s really like an actual savings account, but you can put it into an account to earn interest without getting taxed on it, or (this is my preference), putting it into the stock market via index funds, mutual funds or by buying individual stocks.

DIFFERENCE BETWEEN TFSA AND RRSP

So unlike the Registered Retirement Savings Plan (RRSP) that takes into account how much you put into it and actually lowers your taxable income in the year you contributed, the TFSA takes your net income.

A TFSA is also NOT locked-in money. Unlike with an RRSP where you put in your cash, and can’t touch the balance until you’re 65 without heavy penalties, you can take the money out of the TFSA any time you want or need it.

If you want to know more about this, read this post: Difference between a TFSA and an RRSP – which is better and why?

WHAT CAN’T YOU DO WITH A TFSA?

You can’t take out the money in a year, and re-contribute in the same year or else you’ll have to pay a penalty.

You have to wait until the following calendar year to re-contribute that amount.

For instance, when I moved to the U.S. in 2012, I took out all the money in my TFSA accounts, and moved it.

When I returned to Canada, I had to leave my TFSA money in my regular non-TFSA bank accounts (which is why you see high balances), and wait until 2013 before I could re-contribute.

If I had put the TFSA money back into my accounts in 2012 instead of waiting, I would have been charged a penalty tax.

IS IT CONSIDERED A RETIREMENT SAVINGS ACCOUNT?

Absolutely.

Even if you don’t want to (or can’t?) contribute to an RRSP, you can still contribute to a TFSA.

A reason why you may not be able to contribute to an RRSP would be in my case for instance.

I take my income as a freelancer in dividends, as it is not considered earned income, I don’t get any kind of RRSP contribution room allowance for that year.

It’s still all savings for your retirement, because you have a few rules around not being able to take out the money without waiting for 2013 to re-contribute again.

A TFSA is more flexible as well, because you can take the money out for let’s say a downpayment on a home, without any penalties (although the RRSP also has a Home Buyer’s Plan, but you have to put the money back within a certain time period).

You can also take the TFSA out for emergencies, like repairs on your car or your house.

WHY WOULDN’T I JUST PUT MY MONEY INTO A REGULAR SAVINGS ACCOUNT INSTEAD?

Any money you earn as interest, or as gains on the stock market (profits) will be taxed each year.

EXAMPLE OF WHAT KIND OF INCOME YOU CAN PUT INTO AN TFSA

An example, is if you make $30,000 a year, not taking into consideration any tax deductions (such as if you contributed to an RRSP), you pay about $4000 in taxes.

You’re left with $26,000 a year, and out of that $26,000 net income, you can put $5000 of it into an TFSA every year.

If you make the same $30,000 a year, and you decide to put that $5000 into an RRSP instead, you will pay about $3000 in taxes, or $1000 less, but when you go to take the money out at 65, you will be taxed on the money then.

Note: An RRSP’s limit is 18% of your earned income in a year. Dividends do not count as ‘earned’ income. So if you make $30,000 a year, 18% of that is about $5400 and that’d be your RRSP contribution room for that year, plus any unused contribution room from previous years.

HOW DO YOU KNOW HOW MUCH TFSA CONTRIBUTION ROOM YOU HAVE?

From your tax assessment statements which usually show up around March if you filed early.

If your income is anything like mine (a mix of earned and dividends), or if you took money out, you can also go online to the Canada Revenue Agency (CRA) Site, sign up for a My CRA Account by creating a CRA Login, and look at all your past tax statements online.

CAN I GIVE MONEY TO PEOPLE TO INVEST IN THEIR TFSAs?

Sure, but it is money that you give to let THEM invest in THEIR TFSA.

So for instance if you give your partner or your mother, all $5000 and tell them to put it into their TFSA, it’s under their name, so you might want to get a piece of paper stating something contractual to that effect if you aren’t planning on gifting them the money outright.

It isn’t illegal, but as it is all income-after-taxes (net income), you won’t be getting any tax breaks, but your money will grow in their accounts tax-free.

They won’t be able to contribute to their TFSA however, because your money will be sitting there instead.

IS THE TFSA A BANK ACCOUNT? 

A TFSA is a conceptual saving account that is tied to your name and Social Insurance Number (SIN).

You have TFSA contribution room (let’s say $5000 this year), and you can put that $5000 into savings account held at multiple banks.

You could technically have $1000 in a TFSA saved in Bank A, $1000 in Bank B, and $3000 in Bank C.

Or all $5000 in Bank A.

All that matters is how much TFSA contribution room you have, and that you don’t go over the limit.

WHERE YOU CAN OPEN A TFSA ACCOUNT

Any Canadian bank or brokerage as long as it says: TFSA in the name.

WHAT CAN YOU PUT INTO A TFSA ACCOUNT?

You can put your money into your TFSA contribution room by using any of these options (also known as “saving & investing vehicles” if you want to get fancy):

• Individual Stocks
• High-Interest Savings Accounts
• Bonds
• Government-Insured Certificates (GICs)
• Mutual Funds
• Index Funds

… basically any (legal) way you want to save and grow your money is allowed.

That said, please don’t waste your TFSA room on saving it in an high interest savings account (which is just like cash), or in GICs unless you plan on requiring the money for something (car, down payment on a home) and withdrawing the money very soon (within the year or two).

Investing it in the stock market either with dividend paying stocks or in index-tracking funds (mutual funds or exchange-traded funds), is a better long-term solution.

DIVIDEND INVESTING

• Overview of dividend investing
• How to pay less than $200 in taxes in Ontario on $50,000 of income
• How to build a dividend investing stock portfolio

INDEX-TRACKING FUNDS

• What is the difference between a mutual fund and an exchange-traded fund?
• How to invest in index funds
• How do I set up an index fund portfolio?
• What is an “MER” or Management Expense Ratio?
• How to look for and choose an index fund to invest in