Investments & RRSP, Tips & advice

The Basics of the Tax-Free Savings Account

The Tax-Free Savings Account (TFSA) is one of the newest investing vehicles on the block, but there are still lingering questions on how to use it.

The federal government created the TFSA back in 2009 as a way to help people grow their investments, tax-free. For all your other investments, taxes can eat a huge chunk of your capital gains.

TFSAs are a great saving tool, but there are some rules investors should keep in mind to avoid losing money.

Don’t over contribute

From 2009 through to last year, Canadians were allotted a $5,000 contribution limit each year. On January 1st the contribution limit was increased to $5,500, which means Canadians have a maximum deposit amount of $25,500. (This only applies if you were 18 years old or over in 2009 and had a valid SIN card.) Even if you didn’t open a TFSA in 2009, your contribution room accumulates.

The TFSA is a great place to stash your savings, but if you over contribute you’ll be taxed one per cent for every month that excess contribution stays within the account. Don’t lose money when you don’t have to.

Keep track of your withdrawals

You can withdraw from your TFSA without any consequences, but keep tally of how much you deposit back. If you deposited the maximum amount for the year, then withdraw money, you need to wait until next year to deposit the money back in or you’ll be charged as over contributing. But, the withdrawal you made will be added to your next year’s contribution room without you being charged any fees.

If you’re switching TFSA accounts, you can transfer the money from one TFSA to another without any tax consequences, but you need to make sure it’s done by the financial institution. If you go in and withdraw that money and move it to the other bank, then you’ll be dinged as over contributing. The Canada Revenue Agency offers other scenarios where you can transfer funds from your TFSA without being hit with taxes.

It’s not just a savings account

Thanks to its name as a TFSA, a common misconception is that its sole purpose is as another savings account. With interest rates at all-time lows, this probably isn’t the best use of the account.

Consider investing in other saving vehicles such as mutual funds, the stock market, GICs or bonds within your account. For specific rules on what you can invest in, visit the CRA website.