Are you using your TFSA the right way?
Tax-free savings accounts can provide fabulous opportunities for savers and investors. But they are not investments
Q: I’ll need a new car in the next couple of years and want to save as much as I can for it. Are TFSAs a good investment for this?
A: Tax-free savings accounts (TFSAs) provide fabulous opportunities for savers and investors. But they are not investments. This often comes as a surprise to many folks, so let me give you a little refresher.
Tax-free savings accounts were introduced in Canada in 2009, as a type of account allowing individuals to save money in a tax-free environment. That is, no taxes are applied on any investment income earned in a TFSA, including interest, dividends or capital gains. Additionally, any amount can be withdrawn from a TFSA on a tax-free basis.
TFSAs are available to Canadian residents aged 18 and older who have a valid SIN (social insurance number). Only individuals can establish a TFSA; corporate and spousal TFSAs are not permitted.
TFSAs can be used for just about any purpose, such as retirement savings, education funding, gifting to family or charity, an emergency fund, a holiday fund, or — in your case — a new car fund.
The annual contribution limit has varied over the years, but the 2019 limit is $6,000. This limit is indexed to inflation using the Consumer Price Index (CPI) as reported by Statistics Canada and rounded to the nearest $500. Any contribution amount not made to a TFSA can be carried forward indefinitely to future years. Likewise, any amounts withdrawn from a TFSA in a given year will be added to the individual’s contribution room for the following year. Since the inception of the TFSA, the total current cumulative limit is $63,500.
You’ll want to be very cautious about contributions to your TFSA in excess of your maximum limit because those surplus amounts are subject to a tax penalty of 1 per cent per month. That’s a hefty price to pay — and you may not realize your error until months after the fact.
Unlike Registered Retirement Savings Plans (RRSPs), TFSA limits are not based on earned income, contributions to a TFSA are not deducted from your income to reduce the amount of tax you owe, and withdrawals from a TFSA are not added to your income. Additionally, there are no age limits on TFSA contributions whereas contributions to an RRSP can only occur up to and including the year in which the individual turns 71 years of age.
Now that we have the TFSA rules under our belt, remember that TFSAs are
not investments. Instead, think of a TFSA like a box in which you put investments. The type of investment you choose will depend on various factors, such as when you’ll require the funds. Perhaps you’ll use the investments inside your TFSA to fund your future retirement lifestyle. Or maybe your TFSA investments will be used in the nearer future to purchase your next vehicle.
There are some non-eligible investments and some restrictions on investing in TFSAs in specific situations, but in general, just about any type of investment can go into your TFSA box, such as term deposits, corporate and government bonds, shares of companies, mutual funds, and GICs (Guaranteed Investment Certificates). And, of course, the investments you choose to put in a TFSA for retirement may be very different from the investments that are most suitable for next year’s car fund because the purpose and time frame for those two financial goals are very different.
Accordingly, the first step is to determine the purpose of monies contributed to your TFSA box. Then the second step is to determine the most appropriate investment to be held in that TFSA box for your specific purpose.
Just remember, the income earned on the investments held in your tax-free savings account box won’t be taxable. Nor will you owe any tax when the investments are redeemed and then withdrawn from the TFSA to fund the purpose for which they were invested.
So just be sure you have the right investment for the right purpose inside your TFSA box and then you’ll have the right idea — all tax-free, of course.
Thie Convery, R.F.P., CFP, CIM, FMA, FCSI, is a wealth advisor in Dundas. Her column appears bi-weekly in The Hamilton Spectator. You can reach her with questions at TheSpecMoney@gmail.com or by visiting ConveryWealth.com.