Over the years at CH Financial, we have received questions about how Tax-Free Savings Accounts (TFSA) work. For any Canadians over the age of 18, we believe that TFSAs play a crucial part of our client’s investment portfolio. In this article we will not only discuss how a TFSA works but also how to best utilize your TFSA.
What is a TFSA?
The TFSA program begin in Canada in 2009. Any individual who is a Canadian resident and is 18 or older can set aside tax-free money during their lifetime. Money contributed to a TFSA has already been taxed, and after the contribution will never be taxed again. Withdrawals are likewise made tax free.
Contributions and Withdrawals
Every year the accountholder is allotted contribution room, which can be carried forward if it’s not used in that year. For example, if an individual turned 18 in 2018 and has not made any contributions, the individual would have a total of $17,500. On the other hand, if an individual turned 18 before 2009 (when the program began) and has not made any contributions, the individual would have a total of $69,500 in contribution room.
Finally, any money withdrawn from a TFSA becomes a part of the next calendar year’s available contribution room. So, for example, if someone were to take out $10,000 from their TFSA in 2020 on January 1, 2021 they will have a total of $16,000 of contribution room in their TFSA (the $10,000 withdrawn previously plus $6,000 for the new year).
How to utilize your TFSA
A TFSA is a registered account like a RRSP but the two account types have very different mandates. An RRSP account encourages the accountholder to save money by deferring taxes to later years (when the accountholder is in a lower tax bracket). Any withdrawals made from a RRSP is fully taxable in the year of that withdrawal. TFSA’s by contrast will never create a tax liability at any point in the future! Since there is no tax paid to withdraw from a TFSA, we advise clients who are planning on any large purchase (for example, vehicle purchases, future tuition, home renovations, etc.) to withdraw from their TFSA account.
TFSAs are a powerful planning tool allowing Canadians to build a pool of tax-free assets that can be used at any point in their lifetime. Please feel free to contact a member of the CH team, as we would be more than happy to chat further about your TFSA and answer any questions you have.