Tax free savings account written out under TFSA on post it note with stationary around it

How to Use a TFSA (Tax-Free Savings Account)

Whether you’re saving for a short-term goal, like buying a car or home, or saving for retirement, investing in a tax-free savings account (TFSA) is a flexible way to set aside funds and earn tax-free interest.

Anyone who is the age of majority in their province and who holds a valid Canadian social insurance number (SIN) can open a TFSA account. Banks, credit unions, insurance, or trust companies can all issue TFSAs.

TFSAs are not like regular savings accounts. As registered investments, they come with benefits such as tax-free earnings and withdrawals.

There are three types of TFSAs: a deposit account (where an individual adds contributions for savings goals), an annuity contract (where you make regular withdrawals in intervals), and an arrangement in trust (where the trust owns the TFSA). You can add more than funds to your account. Other investment products, like stocks and GICs, can be purchased with a TFSA.

Essentially, TFSA’s are a vehicle to drive your Investments or save your money In. TFSA’s will not earn you any money unless you set up your account to do so. It’s important to learn how to use a TFSA to maximize its benefits.

What is a Self-Directed TFSA?

If you opt for a self-directed TFSA, you will be responsible for managing the account yourself. Setting up regular pre-authorized deposits to your account is the easiest way to add cash contributions. Many financial institutions allow you to monitor transactions and download statements online to log these contributions accurately.

If you have a personal investment account, you can also use your TFSA to purchase investments, like GICs, bonds, mutual funds, and equity stocks. The advantage of this type of TFSA is that you do not pay service fees to an investment broker.

Instead, you will buy and sell these investment products yourself and monitor gains and losses on your own. Any losses you incur on these investments will not be counted as a withdrawal against your contribution limit. 

How to Open a TFSA

You will need to contact your financial institution to set up your account. Be sure to have your SIN ready and other personal information available for the application. You may need to provide copies of those documents as proof.

Though you must be the age of majority in your province to open the account, you begin to build up contribution room in the year you turn 18 years old.

Can You Register More than One TFSA?

Yes, but management becomes more complicated, as your contribution limit across all accounts stays the same. For example, if your limit for the year is $6,000, that is the maximum allowable amount across all of your TSFA accounts combined. You will incur a tax penalty if you add more than the allowed limit between the multiple accounts.

Keeping track of how much you’ve contributed or re-contributed across all accounts is paramount to ensure you are within your contribution room, so you don’t get penalized.

How to Invest TFSA in Stocks

How to invest TFSA in stocks

TFSAs can include many investments, like cash, GICs (Guaranteed Investment certificates), bonds, stocks, mutual funds, and options contracts.

Contact your financial provider to ensure your TFSA account allows you to purchase stocks and other investment products, like options contracts.

Any return earned on investments purchased with your TFSA will be shielded from taxes for life, making it an investment strategy worth pursuing.

However, be mindful of riskier strategies, like options trading in a TFSA. Investopedia describes options as financial derivatives that give buyers the right, but not the obligation, to buy or sell an underlying asset at an agreed-upon price and date.

The Canada Revenue Agency (CRA) monitors these transactions. If they find an investor is using a TFSA only to generate a significant return, those earnings will be subject to tax. Therefore, it’s wise if using your TFSA to buy and sell options to do so only to offset other investment losses.

How to Withdraw from TFSA

Unlike with an RRSP, taking money out of TSFA is not limited by circumstances, like first-time homebuyers and RRSPs. There are no stipulations on when and for what you want to withdraw the funds. You can withdraw funds from your TFSA at any time without paying any taxes.

However, the withdrawal doesn’t open the amount of available contributions for the year. In fact, if you have already contributed your total amount for the year and then take funds out, it is best to wait until the next calendar year to re-contribute those funds to your TSFA. Withdrawals will be added back to your overall limit in the following year. Therefore, you need to keep close track of your contributions or withdrawals, so you don’t incur a tax penalty.

How to Calculate TFSA Room

Every year, the TSFA contribution limit is set by the amount of inflation. Unused portions from previous years can be carried forward to future years. So, if you don’t contribute the maximum amount in the current year, you can “catch up” in following years, as long as you do not exceed your overall contribution limit.

For example, you made the maximum contribution allowable for past years before 2020 but only contributed $3000 in 2020, which is half the allowable amount. Therefore, for 2021, you will have both the 2021 maximum contribution limit of $6000 and the $3000 carried over from 2020, for a total of $9000 of contribution room for 2021.

Here is the list of limits since the program started in 2009

     •    2009-2012 – $5,000 per year

     •    2013-2014 – $5,500 per year

     •    2015 – $10,000

     •    2016-2018 – $5,500 per year

     •    2019-2021 – $6,000 per year

Therefore, if in 2021 you had never set up a TFSA account, you could potentially contribute up to $75,500 tax-free in a new account, as long as you were 18 years of age at some point in 2009.

Which is Better RRSP or TFSA?

Since earnings on contributions to both RRSP and TFSA accounts are tax-free, they both are excellent ways to invest in your financial future. However, when you will need those funds and
what you will use them for will be essential factors in which option you choose.

For short-term savings goals, where you are likely to withdraw funds within 3-5 years, investing in a TFSA makes the most sense since you can remove all or a portion of the funds without penalty. You can even reinvest those funds later and still remain within your tax-free contribution limit.

RRSPs are limited to retirement savings but allow for withdrawals for first-time home buyers. Unlike TFSAs, RRSP contributions are tax-deductible, making them an excellent long-term investment.

Depending on your income, your contribution limit can be much larger with an RRSP than with a TFSA. Any RRSP withdrawals for any reason are taxable as income. TFSAs also have no age limit, and anyone, even someone unemployed, can contribute.

RRSPs require the account holder to be earning an income. There is also an age limit of 71, at which time the RRSP will be converted to an annual annuity or a Registered Retirement Income Fund (RRIF).

Consider reaching out to a trusted financial advisor to help you navigate the options and choose the best product for your needs and saving goals.

By: Robert Puharich | December 7, 2021 |

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