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What You Need to Know about a TFSA and How it Works

The Tax-Free Savings Account — TFSA — is a great savings incentive for Canadians. It is a savings and investment account that Imposes NO taxes on contributions or the interest they earn — even beyond the lifetime of the owner. That exemption includes dividends or capital gains, which can be withdrawn tax free. The account is available to Canadian residents who are ages 18 and older and hold a valid social insurance number.

Canada introduced the TFSA back in 2009 and current contribution limits through 2021 are $6,000 annually.1 The money you contribute to a TFSA is after-tax dollars, and those contributions are not tax-deductible. 

TFSA Contribution Limits and Carryovers

If you have not reached your contribution limit for a year, you can carry over the so-called “unused room” forward to the next year. So, if in 2020 you only contributed $2,000 of your $6,000 limit, your 2021 contribution can be $8,000. This option is only eligible to Canadians who maintained a continuous residency status in Canada during the years in which they intended to carryover.1

Withdrawing Money from your TFSA

When you withdraw funds from your TFSA, that amount is added back to your contribution limit at the beginning of the next year. Limits for replacing the money at a later time depend on how much contribution room remains after the withdrawal, your cumulative limit, and how much you contributed during that year.

To avoid over-contribution penalties, it's important to keep an eye on your account’s cumulative limit as well as your annual carry over eligibility.

Penalty for Contributing Over the Maximum Amount

If you make a contribution to your TFSA and that contribution takes you past the annual limit or above the allowable cumulative limit, it is considered an over-contribution. Once that happens you can expect a tax penalty of 1 percent each month on the excess contribution until you withdraw it.

A TFSA Can Hold Much More than Just Cash 

You can open a TFSA account consisting of a wide variety of investment tools: stocks, bonds, mutual funds, etc. Investment income in Canada is typically taxed at the highest marginal rate. That income will be added to the rest of your earnings and bring up your tax bill. 

The good news is that if the aforementioned investment income is in a TFSA account, you do NOT have to report it. However, you cannot write off TFSA account losses to offset the gains in a non-TFSA account. They are separate entities under Canadian tax law.

A TFSA Can Be Used as an Education Savings Plan Alternative

The Canada Education Savings Grant is restricted to qualified post-secondary education programs. When you use TFSA funds, those restrictions do not apply.2 This might be a benefit if, for example, the child does not plan on attending college and needs to pay secondary school expenses now. If you are willing to forgo the Canada Education Savings Grant, the TFSA is an alternative.

Transferring Your TFSA Assets

Upon the death of a TFSA holder, the assets can be transferred to the spouse with no effect on the spouse’s existing contribution limit. The surviving spouse receives the money, which is tax-sheltered. Those assets will likewise be passed on to the spouse’s estate or beneficiary, again, tax-free.

The TFSA provides a way for Canadians of all ages to invest in a lifetime of savings with an additional nest egg for retirement. For example, a 45-year-old who contributes the maximum each year for 20 years into an account that earns a five percent return will end up with a TSFA valued at over $186,000 — and never pay a dime in income tax on it.

  1. https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/rc4466/tax-free-savings-account-tfsa-guide-individuals.html
  2. https://www.canada.ca/en/services/benefits/education/education-savings/savings-grant.html

This content is developed from sources believed to be providing accurate information, and provided by Twenty Over Ten. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.

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