Tax-Free Savings Account: Open an Individual TFSA in Canada

Did you know that over a third of Canadians aren’t aware of how Tax-Free Savings Accounts work?

TFSA is rather ill-named giving people the impression that it’s just a savings account, but it is actually a tax-sheltered investment vehicle that Canadians should be taking advantage of. Rather, it should have been called a tax-free investment account but regardless, it’s a powerful way to build your future because you don’t get taxed on your investment growth, nor when you withdraw your funds at a later time.

As a Canadian citizen or resident, it is important for you to be well-informed of this lucrative tax-sheltered investment opportunity, so you can take advantage of this program, save more for your future and withdraw funds tax-free from your TFSA.

What is a TFSA

A TFSA, or Tax-Free Savings Account, is one of the best ways to invest for the future!

It is a government of Canada savings program initiated to encourage Canadians to invest more and take advantage of tax-free asset growth.

TFSA accounts are flexible and can be used as an emergency fund or retirement investment account. The money that goes into a TFSA is not taxed when it comes out, the growth inside a TFSA account also doesn’t get taxed. That means that every dollar invested can grow faster compared to non-registered investment accounts.

Unlike RRSP, which is a registered retirement savings plan, contributions to a TFSA are not tax-deductible. However, unlike an RRSP, there is no maximum age limit for contributing to a TFSA and you don’t have to stop contributing at any time.

TFSAs can hold many different types of investments, including cash, GICs, stocks, bonds, segregated funds, and mutual funds.

Who is eligible for a TFSA

man holding piggy bank

To be eligible for a TFSA, you must be a Canadian resident at least 18 years old. You don’t have to have earned income to contribute to a TFSA, but there are annual contribution limits, however, any unused annual limit accumulates and adds up over time.

For 2021, the annual TFSA limit is $6,000, this increases by an average of $500 every year until it reaches the full amount.

If you have a high income and have made a large TFSA contribution in the past year, there may be overcontribution penalties at tax time if you’ve exceeded your accumulated contribution limit. You can normally replace the funds you withdraw, but TFSA withdrawals don’t necessarily free up or return the contribution room for the amount you’ve withdrawn, which could result in overcontribution penalties.

How to open a TFSA in Canada

You can open a TFSA at any bank, credit union, or independent financial advisors (like us) that offers them.

To open an account, you’ll need to provide some personal information, including your social insurance number and date of birth. You may also be asked for proof of your Canadian residency and identity. This requirement is to make sure that you are a Canadian resident for tax purposes and are therefore qualified to make TFSA contributions.

You won’t need a minimum amount of money or contribution before opening your account, and there are no fees for opening one as long as it’s with an institution that offers them.

There may be fees for managing the investments inside your TFSA account such as management expense ratios so you can in turn focus on doing the things you do best and automate your investing as a passive investor.

How does a TFSA work?

A Tax-Free Savings Account is much like an RRSP in that it’s a personal investment account registered with the federal government that allows you to save money tax-free. The main difference is that while an RRSP is designed specifically for retirement savings, a TFSA can be used for a variety of short and long-term goals.

You can contribute any amount you want to your TFSA as long as it falls within your accumulated contribution limit (which varies depending on your age).

The money you contribute to your TFSA can be used to buy any type of investment, including cash, GICs, stocks, bonds, segregated funds, and mutual funds. All income and capital gains generated from these investments are also tax-free.

When you withdraw money from your TFSA, you won’t have to pay taxes on it – no matter what the withdrawal purpose is. This makes a TFSA a great place to save for short-term expenses, such as a down payment on a home or car, or for longer-term goals, like retirement.

family saving in piggy bank

What are the benefits of using a TFSA?

Below are several key benefits of using a TFSA:

1) Tax-free growth – All income and capital gains generated from your investments will not be taxed.

2) Tax-free withdrawals – Withdrawals of money from a TFSA account will not result in any tax payable, regardless of what the withdrawal was for (e.g. retirement savings or vacation).

3) Not reportable on income tax return – Since withdrawals are not considered taxable events, you won’t have to consider them when filing your annual income taxes with the CRA.

4) Flexible contribution limit – You can contribute as much or as little to your TFSA as you want, whenever you want, up until the contribution deadline which is usually December 31st of each year. Note, however, that missing the deadline isn’t a big deal since any unused contributions get added to your total accumulated TFSA contribution limit.

What are some common misconceptions about TFSAs?

There are a few misconceptions about TFSAs that are very common, but not true.

1) You can use your TFSA to save for your children’s education. The main purpose of the TFSA is to save for short and long-term goals, such as an emergency fund, home or car purchase, a wedding, a well-deserved vacation, or even your retirement funds.

You may have heard some people advise you to save up your children’s educational funds in a Tax-Free Savings Account, and while this is definitely doable, and a lot of Canadian parents are actually doing this. TFSA is actually the wrong tool for the job as you’re missing out on government grants that your child’s funds would have earned if it’s saved up in a Registered Education Savings Plan.

2) Money inside the TFSA doesn’t grow tax-free – Any income generated from investments held inside your TFSA will be subject to taxation.

As the name itself suggests, TFSA is a “tax-free” savings account, any income generated from investments held inside your TFSA aren’t subject to taxation while they accumulate or when you withdraw.

3) Your contributions are tax-deductible – while your investments can grow tax-free inside a TFSA, your contributions aren’t tax-deductible. TFSA is created for Canadians who are in the low-income tax bracket or are not comfortable contributing to their RRSPs since a registered retirement savings plan is 100% taxable at withdrawal.

If you’re looking to deduct your investment contributions from your taxable income, you should consider RRSP since any contributions you make into it are deducted from your taxable income for tax purposes.

4) You can’t contribute to a TFSA while receiving OAS or if you’re retired – while you can’t contribute to a TFSA unless you’re at least 18 years of age, you can continue contributing to it and take advantage of tax-free asset growth even when you’re retired, receiving CPP and/or OAS.

Is TFSA right for me?

is tfsa right for me

A Tax-Free Savings Account is an excellent way to save or invest for short and long-term goals in a tax-friendly environment.

You should consider opening one if any of these apply:

1) You have money sitting in cash somewhere else earning next to nothing.

2) You don’t want your savings to affect your eligibility for certain government benefits such as OAS.

3) You want to pay less tax on your investment income.

4) You’re not sure what you should do with your money and you want to keep it flexible.

If you have any other questions about TFSAs, or if you want advice on what type of investments would be best for you, speak to a financial advisor

How to Open a Tax-Free Savings Account - Canada

requirements to open a tfsa

To open a TFSA account you need the following:  

  • Proof of Canadian Residency;  
  • Social Insurance Number;
  • Bank account;
  • Government-issued identification (ID)

It’s also a good idea to check your latest CRA assessment to determine how much room you have to contribute, especially if you’re planning to do a lump-sum contribution to avoid penalties on over-contribution. This is available at any time by logging in to your MyCRA account on the CRA website. Alternatively, you can also call CRA to request a printout if you don’t have a MyCRA account yet or you could just ask them as to how much your accumulated limit is.

When you open your TFSA, you can either set up automatic bi-weekly or monthly contributions through a pre-authorized debit agreement, contribute a lump sum, or contribute on an annual basis.

Most financial institutions that offer TFSAs give account holders an option to open their own online access accounts so they can monitor the progress of their investment, print forms, or print their TFSA statements.

Types of TFSAs - Canada

There are three types of Tax-Free Savings Accounts in Canada:

  • deposits,
  • arrangements in trust, or
  • contract annuities.

The TFSA type depends on the issuing institution, which could either be a bank, a credit union, a trust company, or an insurance company.

TFSA vs RRSP? - Canada

tfsa vs rrsp

You can open both a TFSA and an RRSP account, but you might be wondering: “Should I open a TFSA or an RRSP?”  There are many factors to consider when deciding which one is right for you. The biggest factor may be your income tax bracket and how much contribution limits you have with each of these investment shelters.

TFSA vs RRSP - Canada

1. A TFSA is great for short-term savings goals because money in a TFSA can be withdrawn at any time without penalties or tax events, but RRSPs are an excellent choice for long-term retirement savings since you get to deduct your annual contributions from your earned income for income tax purposes, thereby allowing you to defer your tax payment on the amount of money that you contribute into the plan.

2. A TFSA is better for those who have no other savings vehicles because there are many withdrawal restrictions with an RRSP – it isn’t advisable to withdraw money from your RRSP before retirement since any money you withdraw gets added to your total earned income for the year.

Say, for example, you’ve earned $60,000.00 in taxable income for the year and you withdrew $20,000.00 from your RRSP, you will be taxed at $80,000.00 income tax bracket at the year of withdrawal.

There are only two ways on how you can access your funds inside your RRSP without getting taxed outright:

  1. The Homebuyer Program or HBP, and
  2. Life-Long Learning

3. A TFSA is great for those wanting to save for short-term goals like travel, renovations, emergency funds, or any other planned expenses because there are no withholding taxes on withdrawals used for income.

4. An RRSP is better if you want to save for retirement and invest for the long term since it allows you to lower your income tax bracket while you’re actively working, (your tax refund can then be reinvested in a TFSA – you can book an appointment here to see if this strategy applies to you) and only start withdrawing funds when your tax bracket is much lower at retirement.

6. An RRSP offers better tax benefits than a TFSA because you do not pay taxes on the contributions until you access them, at which point you will be taxed based on your marginal or top tax bracket – much lower than the taxes due on contributions and withdrawals to a TFSA.

7. A TFSA is better for those who don’t have much income or those who earn little interest from investments because withdrawals will not be taxed as income – you only pay tax when you cash out your investment, which can be very beneficial if you are in a low tax bracket.

8. A TFSA is great for individuals who want to invest for retirement but aren’t comfortable putting away money in RRSP because of the RRSP withdrawal restrictions.

9. The annual contribution room in an RRSP is calculated based on earned income from the previous tax year; TFSA offers the same annual limit to everyone regardless of income.

10. An RRSP is better if you want to save or invest for retirement and accumulate tax-deferred compounded returns over time. There are tax consequences at withdrawal since any amount you withdraw gets added to your total taxable income for the year. If there’s a possibility for you to draw money from your funds before retirement, it’s good to invest inside a TFSA.

build your wealth

How much money can you put in a tax-free savings account in Canada?

As of this writing (2021), you can contribute up to $6,000.00 a year in your TFSA.

If you are age 18 or older, you would have already accumulated TFSA room from 2009 when TFSA started.

Say, you turned 18 in 2009, the average annual contribution limit was between $5,000.00and $5,500.00, so if you’ve never contributed to your TFSA, you would have at least $60,000.00 in your TFSA contribution room.

Get Started with Your TFSA

As mentioned, you can open a TFSA account with your financial institution, which will usually be placed in a GIC, a regular savings account (TFSA sheltered), or mutual funds. If you want to take advantage of having estate protection in place, we can help you get started with segregated fund TFSA, which offers both maturity and death benefit guarantees.

If you’re interested in opening a TFSA account with us, please book an appointment below at your most convenient time.

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