How TFSA Works, Contribution Limits & Tips to Know in 2023
TSFA is unlike other registered accounts - profits made in a TFSA are tax-sheltered. This allows you to grow your money without worrying about the tax implications. In 2022, the maximum amount you can contribute is $6,000 plus any unused contribution room from previous years. If you’ve never contributed to a TFSA you can invest $81,500 today.
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What is a TFSA?
Tax-Free Savings Account (TFSA) program began in 2009. TFSA is the most powerful tax-advantaged investment vehicle available to individuals who are 18 years old or older and have a valid social insurance number (SIN).
Contributions to a TFSA are not deductible for income tax purposes. However, any income earned in the account (for example, investment income and capital gains) is generally tax-free, even when it is withdrawn. However, administrative or other fees, and any interest on money borrowed to contribute to a TFSA are not tax-deductible.
How the TFSA Works?
All forms of earned income from your investments within your TFSA are tax-free meaning any interest, dividends and capital gains are yours to keep 100%. It is also an excellent savings vehicle, but beyond that, a TFSA is a powerful investment tool since these typically offer a higher return than traditional savings accounts.
Because the investment gains within your TFSA are tax-free, they are also not counted as taxable income and become part of the contribution room you accrue when you make a withdrawal. For example, if you invested $3,000 into your TFSA brokerage account and earned $250 in capital gains, you’d have $3,250 in your TFSA. You could withdraw this full $3,250 completely tax-free. You would then get $3,250 added back to your contribution room the following calendar year.
What are the types of TFSAs?
There are two types of TFSAs that you can open: 1)regular TFSA and 2) self-directed TFSA.
A regular TFSA is a type of savings account that you open with a financial institution. A self-directed TFSA is a type of account that gives you more control over where your money is invested and you can invest in stocks, bonds, mutual funds and more.
TFSA contribution limit
There is a maximum amount that you can contribute to your TFSA and is limited by your annual TFSA contribution room.
Your lifetime TFSA contribution room is the total of the TFSA dollar limit of the current year plus any unused TFSA contribution from previous years. Tje TFSA contribution room that has accumulated since you turned 18.
The annual TFSA dollar limit for the year 2022 is $6,000. If you’ve never contributed to a TFSA you can invest $81,500 today.
If you go over your contribution limit at any time in the year, you will have to pay a penalty of 1% per month of the over-contribution amount until you withdraw it.
Your TFSA contribution room information can be found on your online CRA account or you may also call at 1-800-267-6999.
Withdrawing from a TFSA
Withdrawing from your TFSA is as easy as contributing to it. You simply take the money out, however, you do have to be conscious of how your withdrawals affect your contribution limits that same year.
When you make a withdrawal from your TFSA, you don’t get that contribution room back until the following calendar year. For example, if your TFSA is maxed out and you withdraw $3,000 in June to go on a vacation, you cannot make any further contributions to your TFSA until January 1. At that point, your $3,000 withdrawal will be returned to you as additional contribution room for that year.
How to get the most out of your TFSA?
Since TFSA contributions are made with after-tax earnings, you and your spouse can share a contribution room. The higher income earner can gift dollars to their partner. While it’s tempting to use your TFSA to save for a trip, it’s a waste of the account’s potential. Try to not use your TFSA as a savings account that you withdraw from. Your TFSA works best as an investment account and not a savings account. The ideal use of your TFSA is to start saving for long-term goals or retirement. The longer you let your TFSA grow, the more income you will generate.
Finally, be mindful of your annual and lifetime contribution limits so you don’t go over, as you want to avoid wasting any of your tax-free income on CRA penalty fees.
Since TFSAs are so flexible, it is important to utilize them at every stage of your life while financially planning for the future. As you plan for retirement, there are a lot of considerations for funding your retirement but also for the financial legacy you will eventually leave behind. As part of your estate planning, a TFSA allows you to transfer funds to beneficiaries tax-free.
Our EO CPA team is here to guide you and help you achieve your financial goals. Please feel free to contact us if you have any questions we would be more than happy to help!
Disclaimer: This article is for informational purposes and not intended as accounting or tax advice. Please contact us for an engagement to best assess your specific situation.
Sources:
https://hardbacon.ca/en/investing/the-ultimate-guide-to-tfsas/
https://www.envisionfinancial.ca/simple-advice/wealth/2021-guide-to-tfsas
https://wowa.ca/what-is-a-tfsa-tax-free-savings-account
https://www.fidelity.ca/en/investor/tfsa-guide/
