The importance of savings cannot be understated. The ongoing pandemic has shown us how fickle the economy can be, with unemployment rates jumping to multi-year highs. Canada has several savings options and one such registered account is the highly popular Tax-Free Savings Account (TFSA).
While it is called a ‘savings’ account, the TFSA is an excellent choice of an investment account to generate robust returns on your holdings. You can hold certain investments other than cash that include mutual funds, bonds, and securities in your TFSA.
The TFSA was introduced for Canadian residents in 2009. It was introduced to help Canadians save better. Anyone who is 18 years or older and is a resident of Canada is eligible to open a TFSA. You don’t need to have earned income or file income tax returns to be able to open a TFSA.
According to Investopedia, you can open as many TFSAs as you want but this account has an annual contribution limit. The amount you are allowed to deposit annually in your TFSA is known as your contribution room.
In 2009, the contribution room for a TFSA was $5,000. This limit was increased to $5,500 in 2013 till 2018, except in 2015 when the contribution was increased to $10,000. In 2019 and 2020, it was increased to $6,000. This means the cumulative TFSA contribution room stands at $69,500 in 2020.
Any excess amount deposited in your TFSA is considered as an over-contribution. If you exceed this annual limit, then you have to pay 1% of the excess amount every month as a penalty.
According to the Canada Revenue Agency, you can withdraw any amount from your TFSA at any time. Withdrawing from your account does not reduce the total amount of contributions you have already made for the year and will be added to your contribution room in the next year.
Why should you open a TFSA?
According to GetSmarterAboutMoney, you can benefit from opening a TFSA account in several ways. The major benefit a TFSA gives you is that this account is tax-sheltered. You can withdraw money out of it without having to pay taxes to the Canada Revenue Agency.
If you are already investing in an RRSP for your retirement, then having a TFSA makes perfect sense because you can delay tax payment withdrawal from your RRSP and draw tax-free income from the TFSA.
According to AGF, any income you receive or withdrawals you make from a TFSA will not affect your eligibility to receive income-tested benefits such as the Guaranteed Income Supplement, Canada Child Tax Benefit, or Old Age Security benefits.
It’s a flexible account
The TFSAs also offer a lot of flexibility in terms of contribution room and limit. The funds you withdraw from your account will get restored at the beginning of the next year. For example, if your contribution room for 2020 is $6,000 and you decided to withdraw $4,000 this year, then this contribution space is not lost and you can re-contribute an additional $4,000 in 2021.
However, as mentioned earlier in case you over contribute to your account, you will have to pay a 1% penalty every month till the excess amount sits in the account. You also get a notice about it from the Canada Revenue Agency to make you aware of the excess contribution and the best thing to do is withdraw the over-contribution amount.
If you still don’t withdraw the over-contribution, after you have paid the penalty for the rest of the year, the amount will get adjusted once the new year kicks in and you can contribute to the remaining space in that year.
For example, if your contribution limit was $6,000 and you contributed $8,000 in a particular year then you have to pay the penalty on the extra $2,000 and if this amount sits in your account, it will get adjusted in next year’s contribution room.
The best way to avoid over contributing to your account is to know your personal limit before you start investing.
How to make the most out of your TFSA?
TFSAs are different than other savings accounts and if you plan your investment portfolio aptly, you can earn a lot more than you can imagine. For this, you can also consider taking professional advice from a financial advisor.
One thing you should keep in mind is that TFSAs can hold stock, bonds, GICs, mutual funds, and many other investment products. If invested smartly, a diversified portfolio tends to give huge profits and returns over time.
Further, any capital gain, dividend, or interest you earn on your investments is not taxed and they don’t impact your contribution space either. This is another reason why you should consider multiple investment tools.
You can open as many TFSAs as you want. A simple way to do it is to segregate them into long-term and short-term goals. You can have a TFSA account for your short-term goals like saving for a vacation abroad or buying a car and you can have another one for long-term goals like retirement. This makes your investments manageable and organized.
Owning a TFSA will give a number of benefits. You can invest in this account according to your income and financial goals. Saving money varies from individual to individual but the TFSA is an option that suits almost every individual.