A mini glossary to help you better understand the TFSA
We've put together a list of important TFSA terms to demystify this investment option.
Created in 2009, the tax-free savings account (TFSA) is a savings account registered with the Canada Revenue Agency. The funds you place in a TFSA can earn you investment income that is exempted from federal and provincial income tax. In other words, any investment income earned within a TFSA is not taxable.
All Canadian residents aged 18 and older who have a valid social insurance number (SIN) can open a TFSA and enjoy its many benefits. There are plenty of reasons to invest in a TFSA: it's a great way to save for a passion project, build a financial cushion, or simply boost your retirement savings.
This savings vehicle also complements the advantages of an RRSP and becomes an interesting option once you've reached your RRSP contribution limit.
The following glossary will help you better understand how the TFSA works and whether it's right for your needs.
Each year, there's a maximum amount you're allowed to contribute to your TFSA. This is your contribution room. Keep in mind that, unlike RRSP contributions, the funds you place in a TFSA are not tax-deductible.
The maximum amount to which you're entitled is determined annually based on the following factors:
- The current year's contribution limit: This generally varies from one year to the next. For instance, the limit was $5,000 from 2009 to 2012, $6,500 in 2023, and $10,000 in 2015.
- Cumulative contribution room: As soon as you turn 18, you begin to accumulate TFSA contribution room. Any unused room is carried forward to the following year. For example, a person born in 1991 or earlier will have a cumulative limit of $88,000 by 2023.
- Amounts withdrawn from a TFSA: If you withdraw amounts from your TFSA this year, you can add them to next year's contribution room. In short, your contribution room is never lost. For example, if you withdrew $5,000 in 2022, this amount was added to your 2023 contribution room.
Leaving Canada and changing your tax residence? Be aware that you can keep your TFSA and that your investment income and withdrawals will continue to be exempt from Canadian tax. However, as long as you live outside the country, you cannot accumulate contribution room.
How to determine your TFSA or RRSP contribution room
There are three ways to determine your RRSP or TFSA contribution room:
- Consult your Canada Revenue Agency (CRA) notice of assessment
- Log in to My AccountAttention, ce lien ouvrira un nouvel onglet. on the CRA website
- Contact the Tax Information Phone Service (TIPS) at 1-800-267-6999
02 Excess contributions
What happens when you exceed your annual contribution room? Any amount exceeding your contribution limit will be taxed at 1 percent for each month that the excess amount remains in your account. In practical terms, if you over-contribute $1,000 to your TFSA, you will pay a $10 penalty per month until the following year, when you'll be granted new contribution room. To avoid paying these penalties, you should withdraw the excess amount as soon as possible.
03Tax-free investment income
Good news! TFSA investment income is exempt from tax for the purposes of Canada's Income Tax Act and Quebec's Taxation Act.
For example, if you have mutual fund units in your TFSA with a 4 percent average annual return, and you invest $6,000, you'll earn approximately $1,300 over five years. Whether or not you withdraw your investment, it remains tax-free.
Comparatively, if you earn $1,300 from a registered RRSP investment, you have to pay tax on that amount upon withdrawal based on your current marginal tax rate.
Savings goals are your reasons for setting money aside. They can vary widely depending on your needs and desires, but also what stage of life you're in. Do you want to increase your retirement savings, put together a down payment for a home, or build an emergency fund?
According to your goals, you can open several TFSAs and invest in the most appropriate savings products, such as guaranteed investment certificates, stocks, bonds, mutual funds, and more. There's a savings tool for every goal!
Withdrawals from your TFSA are not added to your annual income and are therefore exempted from federal and provincial income tax. This is a significant advantage, as they won't affect your tax rate or employee benefits. If you have a modest income, these withdrawals won't affect your eligibility for certain tax credits and pension income.
If you want, you can transferAttention, this link will open a new tab. an investment from one TFSA to another, without tax consequences, as long as your issuer completes a direct transfer on your behalf, as is generally the case when you decide to change financial institutions. However, if you withdraw the amounts yourself to deposit them in another TFSA, your contribution room for the current year will be affected.
Broadening your financial knowledge is the best way to make good financial decisions. This glossary provides an overview of the main features of the TFSA and can help you determine whether this savings tool corresponds to your needs and reality.
To optimize your savings strategy and get the most out of a TFSA, don't hesitate to speak with a personal finance specialist.
Keep your savings local
The TFSA with FlexiFonds not only helps you save for important projects, but also allows you to support the Québec economy thanks to mutual funds that invest primarily here.DISCOVER THE TFSA WITH FLEXIFONDS