The Tax-Free Savings Account (TFSA) was first introduced in 2009 as a new investment account to help Canadians save for the future. The major benefits of the TFSA are the tax-free deposits, growth, and withdrawals from the account. This is a superior product to the Registered Retirement Savings Plan (RRSP), as it allows you access to your money prior to retirement without tax implications. As you look towards the future, the benefit is amplified as withdrawals do not count against Old Age Security (OAS) and potential clawbacks. One aspect of the TFSA that many people have difficulty understanding is the calculation of their total and annual contribution limits.

Total Contribution Limit

The annual contribution limits are rolled over each year. This means that even if you never opened a TFSA before 2009, you still have access to the prior years’ contribution amounts. Your personal contribution limit depends on your age or the year you became a resident of Canada. The first year of eligible contributions is based on the year you turn 18 or 2009, whichever is the earliest. For example, if you turned 18 in 2013, the total contribution amount is the amount from 2013 going forward. If you turned 18, in 2000, the total contribution amount is the amount from 2009 going forward. The annual contribution amount is set by the Government of Canada and has been increasing since 2009.

Growth and Losses

Within your TFSA, you can invest your money in mutual funds, exchange-traded funds (EFTs), and bonds. This allows your investment to grow over time and helps you save for retirement or future purchases. How much your account gains or loses as a result of your investments does not impact your contribution limits; the contribution limit is solely based on your deposits, withdrawals, and carry-forward room.

For instance, if you have maximized your contribution room from 2009 to 2020, your deposit into the investment is $69,500. If during that time, your investments have performed well, your account may have grown to $80,000. For 2021, you can still contribute $6,000 for the year even though the value of your account is now higher than the maximum contribution room of $75,500.

If your investments have not performed well and your account has decreased to $40,000, you can only deposit the 2021 contribution limit, which is $6,000. You do not have the ability to “top up” your investment to the maximum contribution room of $75,500.

Withdrawals and Re-Contributing

An additional benefit of the TFSA is that you do not lose the contribution amount if money is withdrawn from the account. However, calculating your contribution limit becomes a bit more complicated when you start withdrawing money for purchases because withdrawals from the TFSA can be re-contributed the following year. For example, if you have maximized your contribution room from 2009 to 2020, and you withdraw $5,000 in 2020, your total contribution room for the following year is the annual contribution limit plus the withdrawn amount from 2020. Using this example, your total contribution room for 2021 is $11,000 (i.e., $6,000 annual limit + room from the previously withdrawn $5,000). One thing to be mindful of is that re-contributing within the same calendar year can result in over-contributing and have tax implications.

Taxes

A major benefit of the TFSA is the tax-free nature of the account, but if you do not follow the rules for the TFSA, you can incur tax implications or penalties. One of those penalties is an over-contribution tax of 1% monthly until the account balance is corrected. Unlike the RRSP, there is no buffer room of $2,000 of over-contribution room. If you are performing multiple withdrawals and deposits into your TFSA, you need to be extra careful to not over-contribute. Also, there are other potential tax implications, such as day trading, which is the multiple purchasing and selling of stocks. This goes against the TFSA rules of long-term investment and all of your gains could be taxed as business income.

The TFSA is a great tool to help you achieve your goals of retirement or saving for future purchases in the short term. Finding the right balance between investing with your RRSP and your TFSA can help minimize taxes in your retirement and set you up for success. Having a proper portfolio fit to your risk tolerance is also important and should be implemented the same way as it is with your RRSP. Talk to me today about building a financial plan and let’s see how you can best use your RRSP and TFSA for tax savings.