TFSA 101: What you need to know to use it to your advantage

In this article we will turn our attention to TFSA, or Tax-Free Savings Account. Don’t let the name deceive you, though. It is important to understand which parts of TFSA are indeed tax-free. When you allocate your assets to TFSA, the initial deposit is “after-tax”, so, unlike RRSP, it does not create an opportunity to reduce your tax on the amount allocated to the TFSA “container”.

Any increase in the value of assets in TFSA (capital gain), and any income generated by them (interest, dividends) are not included in your taxable income, so they are tax-free. Moreover, any withdrawals from TFSA are not included in your taxable income.

The size of the TFSA container (or TFSA contribution room) is limited and begins accumulating for Canadian residents in the calendar year they turn 18. Every year the TFSA contribution room is increased by the amount decided by the government. So far, this amount has been between $5,000 and $10,000 per year. Since the introduction of TFSA, the maximum accumulated room as of 2021 is $75,500. TFSA contribution room is tracked by the CRA and you can find out what it is in your personal account on CRA website. Note of caution though, the CRA website is not super current on updating your TFSA room, so it’s a good idea to keep track of your contributions and withdrawals separately.

TFSA room accumulates only for Canadian residents, the status being re-assessed for TFSA purposes every calendar year. For any years a person ceases to be a Canadian resident (i.e. spends less than 183 days out of the year in Canada), the TFSA room does not accumulate. However, income earned by TFSA assets or withdrawals from TFSA remain non-taxable even for the years when the holder is not a Canadian resident.

So, one benefit of the TFSA is the tax-free growth of the value of your investment. The payoff is that the size of the TFSA container is limited. If you decide to take money out of TFSA, you are free to do that at any time. If you do that, the TFSA contribution room will decrease by the amount taken out, but only until the end of the calendar year. In the following year, the contribution room will increase again, by the amount of all withdrawals made in the previous year plus the additional amount as decided by the government.

Because of that, if you are planning to withdraw money from multiple sources during the year, one of which is TFSA, it make sense to time the TFSA withdrawal closer to the end of the year, therefore allowing money to grow tax-free as long as possible.

Any decrease in value of your investments is not considered withdrawal. For example, if the company stock you have invested in declined in value below the original purchase price, or even if the company you’ve invested in went bankrupt, you cannot contribute additional amount to replace the money you’ve lost. If you do, it will be considered overcontribution and fined at 1% for each month of overcontribution.

On the other hand, the growth of the underlying investment technically grows your total contribution room. The full amount of money you take out of a TFSA will be made available to you for contributions in the following calendar year. For example, let’s say your investments grew 10% and you are taking out $5,500. Of this $5,500, $5,000 is the original contribution, and $500 is the income. Full $5,500 will be added to your contribution room in the following calendar year.

Any interest, capital gains or dividends earned with TFSA is tax-free. It makes sense to keep higher growth elements of your investment strategy (such as CIG, bonds or bond ETFs) in TFSA while keeping lower growth elements (stocks and stock ETFs) in RRSP so that the tax exposure is be lower.

Another tax consideration, less evident than the personal income tax, is the withholding tax of 15% on dividends paid by the US / foreign corporations. This tax is deducted for Canadian residents before the dividends are paid (hence, withholding). Directly owned US / foreign stocks and ETFs held within RRSP are exempt from this withholding tax. But this exemption does not apply if they are held within a TFSA. It makes it more tax efficient, therefore, to hold Canadian stocks or ETFs (rather than the US stocks / ETFs) in TFSA, assuming similar pre-tax returns.

It should be noted that the intention of TFSA is the long-term accumulation of funds. This is why day trading within TFSA is not allowed and is not tax sheltered.

You can always find your available TFSA contribution room in MyAccount with CRA. To obtain your latest TFSA room from the CRA website, follow these steps:

1) Go to https://www.canada.ca/en/revenue-agency/services/e-services/e-services-individuals/account-individuals.html

2) Log in using one of the three options available for the login (if you have never accessed your My Account with CRA, you may need to register first)

3) If you are looking for a quick one number answer, your TFSA contribution room is shown on the home page of My Account.

4) If you are looking for details, click through to TFSA details and the calculation of the current year’s TFSA contribution room.

5) Note that CRA is not very current with updating TFSA transactions. Please be diligent and check your own records to make sure that your TFSA room is calculated correctly and avoid overcontribution penalties.

Disclaimer: I am not a certified financial planner and this article does not constitute financial advice. Please do your own research before acting on the material of this article.

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