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Your 2021 Guide to Tax-Free Savings Accounts (TFSAs) 

The Tax-Free Savings Account (TFSA) is an incredibly tax-efficient way for Canadians to grow their wealth. It was introduced in 2009 by the Government of Canada to help Canadians save money, but despite its name, it’s not a savings account. It’s more of an investment account, where your money can grow without having to pay tax on the earnings. It can be a little bit confusing — which is probably why many Canadians are not using their TFSA to its full advantage. We're going to answer some of the common questions that people have about TFSAs. 

What’s the difference between an RRSP and a TFSA?

The RRSP is at the core of many Canadians’ retirement savings. The RRSP contribution limit changes each year, but is generally 18 per cent of your income in the previous year. In this way, an RRSP allows you to defer your taxes while saving for retirement. The most important thing to understand is that you will pay tax on this money once you withdraw it.

One of the ways the TFSA is different from the RRSP is that you have already paid taxes on the money you deposit. Your contribution is done with your after-tax dollars, so any interest you earn and withdrawals you make are tax-free. 

Should I choose an RRSP or a TFSA?

Your priorities depend on where you are in life: somebody in their 30s has different goals from somebody in their 40s, 50s and 60s.The TFSA will generally work well for those in a lower income bracket (under $30K annual income) as you will not get the best tax benefits by making an RRSP contribution.

When you are in a higher income bracket (over $30K annual income) you may want to use the RRSP as a way to reduce your taxable income. Ideally, being able to incorporate both RRSPs and TFSAs into your overall investment plan will help you reach your retirement goals earlier. 

Who can open a TFSA?

To open a TFSA, you must be a Canadian resident with a valid Social Insurance Number (SIN), and be at least 18 years old. Unlike an RRSP, which you have to convert into a RRIF when you turn 71, there is no upper age limit — so you could keep contributing to it well after you turn 100!

How much can you put into your TFSA?

With a TFSA you can invest in mutual funds, term deposits, ETFs or even a savings account. There is a limit to how much you can put into your TFSA, and that’s called the contribution limit. Every year, the contribution limit increases and accumulates, which means that if you don’t reach the limit one year, you don’t lose it. As you can see in the table below, the TFSA limit for 2021 is $6,000.

Year           TFSA Contribution Room           TFSA Cumulative Limit

The other thing the TFSA allows you to do is to withdraw money from it without losing your room. For example, if in 2020, you had $69,500 in your TFSA and you took out $2,500 for a trip, that would leave you with $67,000.

$69,500 - $2,500 = $67,000

You don’t forfeit that contribution room: you are still able to put in an extra $2,500 to meet the cumulative $69,500, although you’ll have to wait until the next calendar year to make that contribution. So, you can use your TFSA as a savings vehicle for your short-term goals as well as your long-term goals.

What happens if you over-contribute?

If you go over your contribution limit, you’ll incur some pretty steep tax penalties: one per cent per month of the amount in your TFSA that exceeds the limit.

What are the tax benefits of a TFSA?

With an RRSP, any growth within the portfolio is tax-sheltered and you only pay taxes when you make a withdrawal, which is then taxed as income. Like we mentioned above, with a TFSA, it’s the opposite: the deposits you’ve made have already been taxed as income and when you make a withdrawal, it's tax-free.

Use our TFSA calculator to see the benefits of investing in a TFSA over a non-tax-sheltered investment.

How can you use your TFSA?

There are a lot of ways you can use your Tax-Free Savings Account to help you reach your financial goals. Here are a couple of examples:

To save for a rainy day

Because your withdrawals aren’t taxed as income, your TFSA is an excellent vehicle in which to park your rainy day fund. You can invest it in a redeemable term deposit (e.g., a GIC), so your deposit is guaranteed. 

You’ll be able to cash it out if you suddenly need money, and your rate will be better than with your typical savings account.

To save for a large purchase

If you’re looking to buy a computer, build your holiday budget or plan a getaway, automatically contributing to your TFSA can help you easily grow your money for big-ticket items. 

To save for retirement

Most good retirement plans will leverage both the RRSP and the TFSA. Also, the government has programs in place to support Canadians in retirement, including the Old Age Security (OAS) pension. If your income exceeds the income threshold that the government sets, your payments from these programs are reduced — also called a clawback. Tax-Free Savings Accounts can allow you to avoid clawbacks. 

Get expert advice on savings plans

Although it’s a key component of your savings strategy, your TFSA is so much more than just a savings account. It can become a powerful investment tool if you take advantage of your eligible annual contributions.

Contact our Member Advice Centre or email us to connect with a financial advisor who can help you make the most of your Tax-Free Savings Account. 

Mutual funds, other securities and securities related financial planning services are offered through Credential Securities, a division of Credential Qtrade Securities Inc. Mutual funds and related financial planning services are offered through Credential Asset Management Inc. Financial planning services are available only from advisors who hold financial planning accreditation from applicable regulatory authorities. Credential Securities is a registered mark owned by Aviso Wealth Inc.

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