What is a TFSA?

Why it should be part of your savings plan.

While many Canadians have Tax-Free Savings Accounts (TFSAs), there is still a lot of confusion around what they are actually for. Let’s clear up a common misconception: the TFSA is not designed to be just a simple cash savings account.

TFSAs are actually tax-registered investment accounts that can hold a wide variety of assets. They were started in 2009 as a way to encourage Canadians over 18 to save by providing an account that allows your investments to grow tax-free.

How does a TFSA work?
Every year you can contribute a certain amount to a TFSA, which you open through a financial institution, such as your credit union. All of the investments that you hold within the account grow completely tax-free – this includes interest, capital gains and dividends.

Unused contributions can be carried over to the following year. It’s important not to over-contribute, however, because penalties are high. You can check your contribution limit by calling the CRA’s TIPS line at 1-800-267-6999.

What investments can you hold in a TFSA?
The TFSA is particularly effective at building investments, especially those with high-growth potential, because your gains are completely tax-free. Some of the investments you can include in a TFSA include:

  • Stocks in publicly-listed companies
  • Mutual funds
  • Exchange traded funds (ETFs)
  • Guaranteed investment certificates (GICs)
  • Government and corporate bonds
  • Real estate investment trusts (REITs)

There are some restrictions, however, such as that stocks must be listed on a designated stock exchange. Check with your financial institution to ensure that your investments are eligible because penalties can be high for unqualified investments.

Benefits of having a TFSA
It’s not surprising that over 14 million Canadians have a TFSA, given its advantages:

  • Your investments grow tax-free, including interest, capital gains and dividends
  • It’s flexible: you can take out as much as you like at any time with no tax or penalty
  • A wide variety of investments can be held within it
  • Withdrawals have no negative impact on government benefits
  • You don’t need earned income
  • It can be switched over to your spouse or another beneficiary on death

Disadvantages of a TFSA
While having a TFSA may seem a no-brainer for many people, it does have some drawbacks:

  • Unlike with RRSPs, your TFSA contributions do not lower your taxable income, so they bring no immediate tax benefit
  • You may have to pay withholding tax on foreign dividend payments
  • There can be heavy penalties if you over-contribute or hold non-qualified or prohibited investments
  • It has a low contribution limit compared to RRSPs
  • You can’t claim capital losses within a TFSA

When does it make sense to invest in a TFSA?
TFSAs are an excellent choice for anyone looking to grow their savings tax-free, while being able to withdraw funds at any time with no penalty.

For this reason, TFSAs are perfect for short- and mid-term savings goals, such as a down payment on a home, paying for a wedding or an emergency fund.

In certain situations, TFSAs also make sense for long-term savings, such as retirement. If you’re in a low tax bracket, the immediate tax benefits of an RRSP may not be worthwhile, so a TFSA can be a good way to grow savings that won’t be taxed when you retire. Also, if you’ve maxed out your RRSP contributions, a TFSA is ideal for boosting your retirement savings.

Start Growing Your Savings

If you have any questions about whether a TFSA is right for you, or if you’d like to start growing your savings tax-free, contact us at 1.855.875.2255.

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