Tax-Free Savings Accounts: What You Need to Know

Fall 2011 CSANews Issue 80  |  Posted date : Sep 02, 2011.Back to list

TFSAs offer Canadians an intriguing way to save for their retirement 
Tax-Free Savings Accounts (TFSAs for short) aren't exactly new – they were created by the federal government back in 2008. But several years after their introduction, it seems that many Canadians still don't know all that much about them.

In fact, according to a survey conducted by the Bank of Montreal in November of 2010, nearly two-thirds (64%) of Canadians do not even have a TFSA. Younger Canadians are even less likely to have a TFSA; only 15% of Canadians under the age of 45 have one. Fewer than half of survey respondents knew that cash could be an eligible investment within a TFSA; a mere 20% knew that mutual funds could be held within a TFSA.

Quite frankly, this is surprising. Combined with the traditional RRSP/RRIF, the TFSA is one of the only legitimate "tax shelters" available to Canadians, providing us with the ability to save thousands in taxes as we save for retirement. Simply put, what you don't know about TFSAs could be costing you a lot of money.

In the interest of helping you learn more about this powerful savings tool, here are some frequently asked questions about TFSAs. Hopefully, the answers will help you understand how a TFSA fits into your overall retirement savings strategy.

Question: OK, so what exactly is a TFSA?

Answer: A TFSA is a tax-free investment account, in which you keep eligible investments such as stocks, bonds, GICs or even cold, hard cash. Inside the account, any interest, dividends or capital gains which those investments earn isn't taxed.

Q: And who can open a TFSA?

A: Pretty much anyone. As long as you're over the age of 18 and you have a 
Social Insurance Number (SIN), you can set one up.

Q: How much can I contribute?

A: As the rules stand now, individuals can contribute up to $5,000 to a TFSA every calendar year. The federal government intends to increase this amount over time, to account for inflation and growing personal income levels. In fact, in the most recent federal budget, Finance Minister Jim Flaherty announced the conservative government's intention to raise the annual limit to $10,000 per year once the federal budget is balanced – expected in 2015-2016.

So, to do the math, if you haven't yet opened up a TFSA, you can contribute $15,000 to a new TFSA in 2011 ($5,000 of unused contribution room from the 2008 taxation year, plus $5,000 from 2009, plus $5,000 from 2010 equals $15,000).

Q: Only $5,000 a year? That doesn't sound like much. 

A: Don't be so hasty with that judgment: there are a few things about TFSAs which make that contribution limit seem a lot more substantial.

First of all, you can carry forward TFSA contribution room indefinitely; if you don't use all of it one year, the amount that you can contribute the next year increases accordingly. Keep in mind that you don't have to open a TFSA to accumulate this contribution room – the government keeps track of that for you on the Notice of Assessment (NOA) which you receive after filing your taxes.

Second, if you withdraw money from a TFSA, you can contribute back the same amount without penalty starting on Jan. 1 of the following year (call it a "recontribution"). That's a lot different from an RRSP; if you withdraw from an RRSP, the contribution room is gone for good. So, for example, if you contribute $5,000 to your TFSA in January and you take out $2,500 in March to do some home repairs, you can put the $2,500 back without penalty, but you'll have to wait until next January before you can do it. Otherwise, you'll be paying a 1% penalty per month on the over-contribution ($2,500).

Third, there's no age limit for contributions to a TFSA. This means that you can keep on contributing to a TFSA even if you're 100 years old, giving you even more time for your investments to compound free of tax. This is another big difference from RRSPs, which must be collapsed in the calendar year during which you turn 71 and converted into an RRIF. 

Q: So what investments can I hold in a TFSA?

A: You can keep your money in cash, GICs, bonds, stocks, mutual funds inside a TFSA – or all of the above. Assets such as warrants, options and precious metals are generally eligible, although special rules do apply (for example: warrants must be traded on a designated stock exchange to be eligible; options must be on eligible investments to be considered eligible themselves; precious metals certificates, ETFs and funds are eligible, but most brokerages do not allow physical bullion in a TFSA; etc.).

For more details, visit Canada Revenue Agency's official website:

Whatever asset you put in, any growth (interest, dividends or capital gains) is completely tax-free as long as it stays within the TFSA.

Q: Yeah, but with interest rates so low, how much tax could I really save? So the government is not going to tax me on the 1% I earn on my GIC – big deal!

A: Well, you're right. If you put $5,000 into a GIC yielding, say 1% a year, you'd earn $20 in interest and a TFSA probably wouldn't save you all that much in tax.

But on stock investments, it's a completely different story. If you opened a TFSA today and invested in stocks or stock mutual funds, you could enjoy unlimited growth on your stocks and none of it would ever be taxed. That's big news.

Q: So, do I get a tax refund when I contribute to a TFSA? Like with RRSPs?

A: Unfortunately, no. Unlike an RRSP, contributions to a TFSA are made with after-tax dollars, meaning that they're not tax-deductible.

Q: Hang on a second – if I don't get a tax refund, why on earth would I want to contribute to a TFSA? 

A: Well, the main reason is that any withdrawals from the TFSA are non-taxable. That's completely different from an RRSP, in which the government-required withdrawals are 100% taxable at your marginal rate.

Q: What difference does that make? 

A: It actually matters a great deal, particularly for those who expect to earn a moderate income during retirement, from part-time work, investments, rental income or another income source.

Because you've already paid tax on your TFSA contribution and the government doesn't tax any growth within the plan, you have the freedom to withdraw as little or as much from your TFSA at any time, without worrying about bumping yourself into a higher tax bracket. This is the exact opposite of an RRSP/RRIF, in which you're forced to withdraw a given amount every year after you turn 71, even if you don't really need the money that year.

Think about that for a second: if you're already earning a substantial amount of money in retirement, you're probably already in a high marginal tax bracket. 

Those forced RRSP/RRIF withdrawals will make matters even worse, as they'll be taxed at a very high rate – more than 45% in some provinces! This means that thousands of your retirement savings dollars go to the taxman, not to you. 

With a TFSA, that problem never arises, because withdrawals are never taxed, no matter how much money you earn in a given year.

Q: Well, that certainly sounds good. But if I have a big TFSA, won't that affect my eligibility for Social Security, pensions and other income-tested benefits?

A: Actually, no. Remember, withdrawals from your TFSA are not considered taxable income. Because the calculation of government benefits is based on taxable income, your TFSA will make absolutely no difference to that calculation – no matter how large it is, no matter how much growth you earn over the years, no matter how much money you withdraw from it.

Q: What about a joint or spousal TFSA? Is there such a thing?

A: No, but that doesn't really matter, because you can contribute to a spouse's TFSA without affecting your own contribution room. Income attribution rules, which currently govern RRSPs, do not apply. This means that a retired couple could stash away a combined $10,000 a year without worrying about who earned the money initially.

Q: What if I make a contribution to a TFSA, but then I need the money for something else, such as an emergency?

A: That's the great thing about TFSAs. If you take money out of your TFSA, you don't lose the contribution room – all you have to do is wait until next year and you get it back. This means that you can use your TFSA as a short-term savings slush fund, a place to stash the cash while you're saving for a house, planning a vacation, putting money aside for grandchildren's tuition fees, or whenever you need to.

That said, a lot of institutions which offer TFSAs do charge you a "withdrawal fee" for taking money out of a TFSA. If you plan on making several withdrawals, those fees can add up. If you see yourself using your TFSA in this way, be sure to shop around for an institution that offers a low- or no-fee TFSA. There are some out there.