It’s been 10 years since the federal government introduced it, and the tax-free savings account (TFSA) is as popular as ever. According to Statistics Canada, 13.5 million Canadians had opened one of these flexible investment tools by the end of 2016.
It’s easy to see why. As the name says, any investment you hold inside your TFSA grows tax-free. Plus, you can withdraw from these accounts whenever you want. You can use your TFSA to help pay for a new home, your children’s education or even retirement. And you’re not taxed when you take the money out, either.
How much can you contribute to your TFSA?
For 2019, you can contribute up to $6,000 to your TFSA, and you can carry forward unused contribution room from previous years.
Here’s what that means in dollars and cents: If you were at least 19 in 2009, from then through 2012, you could have contributed up to $5,000 a year. The annual limit jumped to $5,500 for 2013 and 2014, then to $10,000 in 2015. In 2016, the yearly limit dropped back to $5,500, where it remained until 2019, when it rose to $6,000.
So if you’ve never contributed to a TFSA, you could open your first TFSA in 2019 with up to $63,500 in current-year and previous-year contributions.
But despite the versatility of TFSAs, there are some potential slip-ups to watch out for. Here are four, courtesy of Cliff Steele, a certified financial planner with Sun Life Financial.
1. Holding cash in a TFSA
Although they’re called “savings accounts,” TFSAs have little in common with the chequing and savings accounts you use every day. To Steele, that means 1 thing: They’re no place for cash.
“I see a lot of people holding cash in a TFSA, making nothing,” says Steele. “Or in a daily interest account [inside their TFSA], making 0.25% a year or so.”
“They’re getting almost no savings out of that,” he adds, “because if you haven’t earned a meaningful amount of interest, you don’t have to pay tax on it anyway.”
Instead, talk to an advisor about the higher returns you could get with mutual funds and other investments that you can hold in your TFSA.
2. Withdrawing cash to set up a new TFSA
If you’re changing financial institutions, you should pay particular attention to your TFSA, because moving cash from an existing TFSA to a new one could affect your contribution room. “Remember that if you make a withdrawal, you can’t recontribute until the following January 1,” says Steele.
“Say you withdraw all the funds from your TFSA, then set up a new TFSA somewhere else and deposit this money into it,” says Steele. “That entire deposit would count as a new contribution for the year and could trigger an over-contribution penalty.”
The solution? Have your new financial institution make a direct transfer on your behalf.
3. Over-contributing to a TFSA
Many people go over their TFSA contribution limit without knowing it. This happens when they withdraw and deposit money in the same year. They're treating their TFSA like an everyday bank account.
“The thing to remember is that on January 1, you gain two things: The first is more contribution room. The second is that you also get back the room from withdrawals you made in the prior year,” says Steele.
Let’s look at an example: Say you’ve contributed a total of $45,000 to your TFSA since 2009. That means you have $18,500 left in current-year and carried-over contribution room ($63,500 minus $45,000) as of January 2019.
In May 2019, you take out $20,000 to make a big purchase. Then, later in the year, you come into an unexpected windfall and put the full $20,000 back in. But because you didn’t wait until the next calendar year to return the cash, you’ve over-contributed for 2019, by a total of $1,500 (That's $45,000 plus $20,000 minus $63,500).
The penalty? The Canada Revenue Agency (CRA) charges 1% per month for any amount over your total TFSA limit until you take it out. So in the example above, you would pay $15 a month — and it can take the CRA a few months to let you know.
4. Not opening a TFSA at all
It’s still a common myth that if you didn’t open a TFSA in 2009, when these accounts first came on the scene, you’ve missed out on all the years of contribution room since. Actually, you’ve missed out on the investment growth you could have realized, but you haven’t missed the contribution room.
“Even if you haven't opened a TFSA yet, your contribution limit has been growing,” says Steele. “Anyone who was over 18 in 2009 has a $63,500 limit today.”
The bottom line? TFSAs offer tax-free growth and the ability to access your cash at any time. That of course is subject to the terms of the investments in your TFSA, which could include restrictions on withdrawals or guarantees that could be affected by a withdrawal. That makes them a great companion to other investment tools, like RRSPs. To make sure you’re maximizing your TFSA, speak to a financial advisor today.