The Tax-Free Savings Account — TFSA — is a great savings incentive for Canadians. It is a savings and investment account that imposes NO taxes on contributions or the interest it earns — even beyond the lifetime of the owner. That exemption also includes dividends or capital gains, which can be withdrawn tax free. The account is available to Canadian residents who are ages 18 and older and hold a valid social insurance number.
Canada introduced the TFSA in 2009 and the contribution limit for 2020 is $6,000, matching the amount set for 2019. With the 2020 TFSA dollar limit announcement, the total contribution room available in 2020 for someone who has never contributed and who has been eligible for the TFSA since its introduction in 2009 is $69,500.
The annual TFSA dollar limit is indexed to inflation and rounded to the nearest $500. The Canada Revenue Agency’s indexation increase for 2020 is 1.9%.
Anyone 18 or older and who has a valid social insurance number is eligible to open a TFSA. Contribution room accumulates beginning in the year in which a person turns 18.
In provinces and territories where the age of majority is 19, people will accumulate contribution room for the year in which they turn 18 and carry it over to the following year. They can open a TFSA once they turn 19. (The age of majority is 19 in British Columbia, Nova Scotia, New Brunswick, Newfoundland and Labrador, Northwest Territories, Nunavut and Yukon. It is 18 in the other six provinces.)
TFSA Contribution Limits and Carryovers
If you have not reached your contribution limit for a year, you can carry over the so-called “unused room” forward to the next year. So, if in 2019 you only contributed $2,000 of your $6,000 limit, your 2020 contribution can be $10,000. That only applies to Canadians who maintained a continuous residency status in Canada.
Withdrawing Money from your TFSA
When you withdraw funds from your TFSA, that amount is added back to your contribution limit at the beginning of the next year. Limits for replacing the money at a later time depend on how much contribution room remains after the withdrawal, your cumulative limit, and how much you contributed during that year.
Here's a handy formula:
Unused TFSA contribution room to date + total withdrawal made in this year + next year’s TFSA dollar limit = TFSA contribution room at the beginning of next year
To avoid over-contribution penalties, it's important to keep an eye on your account’s cumulative limit as well as your annual carry over eligibility.
Penalty for Contributing Over the Maximum Amount
If you make a contribution to your TFSA and that contribution takes you past the annual limit or above the allowable cumulative limit, it is considered an over-contribution. Once that happens you can expect a tax penalty of 1 percent each month on the excess contribution until you withdraw it.
A TFSA Can Hold Much More than Just Cash
You can open a TFSA account consisting of a wide variety of investment tools: stocks, bonds, mutual funds, GICs etc. Holding investments in a TFSA can be very beneficial because investment income earned in a TFSA account does NOT have to be reported, and therefore taxed, as investment income. However, you cannot write off TFSA account losses to offset the gains in a non-TFSA account. They are separate entities under Canadian tax law.
A TFSA Can Be Used as an Education Savings Plan Alternative
The Canada Education Savings Grant is restricted to qualified post-secondary education programs. When you use TFSA funds, those restrictions do not apply. This might be a benefit if, for example, the child does not plan on attending college and needs to pay secondary school expenses now. If you are willing to forgo the Canada Education Savings Grant, the TFSA is an alternative.
Transferring Your TFSA Assets
Upon the death of a TFSA holder, the assets can be transferred to the spouse with no effect on the spouse’s existing contribution limit. The surviving spouse receives the money, which is tax sheltered. Those assets will likewise be passed on to the spouse’s estate or beneficiary, again, tax free.
The TFSA provides a way for Canadians of all ages to invest in a lifetime of savings with an additional nest egg for retirement. For example, a 45-year-old who contributes the maximum each year for 20 years into an account that earns a 5 percent return will end up with a TSFA valued at over $186,000 — and never pay a dime of income tax on it.
This content is developed from sources believed to be providing accurate information, and provided by Twenty Over Ten. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.