24.4.5 Tax-free Savings Accounts

Introduction to Tax-free Savings Accounts (TFSAs)

A Tax-Free Savings Account (TFSA) is a versatile savings vehicle established by the Canadian government in 2009. This account allows the holder to earn investment income tax-free throughout their lifetime. It offers complete flexibility with respect to the timing and the purpose of withdrawals. However, there are annual limits to the amount that can be contributed.

Basic Tax-Free Savings Account Rules

• Eligibility: Any resident of Canada who is at least 18 years old can open a TFSA, regardless of employment status.
• Source of Contributions: Contributions to a TFSA can come from any source such as tax refunds, gifts, bequests, savings, or earnings from employment or business.

Taxation of a Tax-Free Savings Account

• Non-Deductible Contributions: Contributions to a TFSA are not tax-deductible.
• Tax-Free Earnings: Investment income earned within the TFSA (interest, dividends, capital gains, etc.) is not subject to taxes, neither in the year it is earned nor when it is withdrawn.

Qualified TFSA Investments

TFSAs can be used to hold a wide variety of investments such as:

• Guaranteed Investment Certificates (GICs)
• Savings Accounts
• Stocks
• Bonds
• Mutual Funds

TFSA Contributions

• Annual Contribution Limit: Each year, the Canadian Revenue Agency (CRA) specifies the maximum dollar amount that can be contributed. Unused contribution room from previous years can be carried forward indefinitely and any withdrawals from the TFSA free up contribution room for subsequent years.

• Excess Contributions: Contributions beyond the allowable limit are penalized at 1% per month on the excess amount.

Example of TFSA Contribution Room

If a Canadian who was 18 years old in 2009 has never contributed to a TFSA, then by 2020 their total contribution room would be $69,500. Alternatively, a person who turned 18 in 2016 would have an allowable contribution room of $28,500 by 2020.

TFSA Withdrawals

• Timing and Amount: Withdrawals from a TFSA are completely flexible and tax-free.
• Re-contribution: Amounts withdrawn can be re-contributed starting in the following calendar year, unless the investor has enough unused contribution room to cover the re-contribution in the same year.

Example of TFSA Withdrawal and Re-contribution

Emma, who has $14,000 of unused contribution room, and Liam, who has exhausted his contribution limit, each withdraw $10,000 from their TFSAs in January. Emma can re-contribute her $10,000 any time within the year because she had adequate unused room. Liam has to wait until the next year to re-contribute due to lack of available room.

Uses of a TFSA

Due to its flexibility, a TFSA can serve in meeting various financial needs during different stages of life including:

• Tuition fees or student loans
• Wedding expenses
• Holidays
• Purchasing a car
• Making a down payment on a house

Moreover, TFSAs provide excellent opportunities to build emergency funds or grow one’s estate.

Glossary

• CRA (Canada Revenue Agency): The government body responsible for tax collection and enforcement of tax laws in Canada.
• Contribution Room: The maximum amount that can be contributed to a TFSA in any given year without incurring taxes on excess contributions.
• Qualified Investments: Types of investments that comply with TFSA regulations, allowing them to be held within the account.

Key Takeaways

1. TFSAs offer tax-free investment income and flexible withdrawal options.
2. Any Canadian resident aged 18 or older can open a TFSA and make contributions from a variety of sources.
3. The annual contribution limit changes; unused contribution room can be carried forward indefinitely.
4. Withdrawals are tax-free and amounts withdrawn can be re-contributed in subsequent years, accommodating various life expenses and stages.
5. It’s essential to track and manage contributions to avoid penalties on excess amounts.

Frequently Asked Questions (FAQs)

Q: Can a non-resident of Canada contribute to a TFSA?

A: No, only residents of Canada who are 18 or older can contribute to a TFSA.

Q: What happens if I over-contribute to my TFSA?

A: Any contributions over your limit will be taxed at 1% of the excess amount for each month it remains in the account.

Q: Is there a penalty for withdrawing money from a TFSA?

A: No, there are no penalties or taxes on withdrawals from a TFSA.

Q: What kinds of investments can I hold in a TFSA?

A: TFSAs can hold a variety of investments including savings accounts, GICs, stocks, bonds, and mutual funds.

Q: Can contributions to my TFSA be tax-deductible?

A: No, contributions to a TFSA are not tax-deductible.