Remember when you were a kid and you were scared of ghosts, clowns, and embarrassing yourself in front of your crush? Fast forward to adult life and now paying for groceries, taxes, and the thought of retirement are the things keeping you up at night.
The goal behind everything I do is to take away the fear around tax and money. Instead I want to make it non-threatening, easy to understand, and even fun. So today we're going over the Tax Free Savings Account or TFSA and how it can help you be a little less afraid of retirement and taxes.
First, I want to make it clear that I am not a financial advisor and this is not financial advice. I cannot tell you what to do. Everyone’s situation is different. This is general information but I recommend consulting a certified financial advisor for their personalized recommendation. They will know your situation and be able to make a custom plan based on your goals.
What is a TFSA & the Benefits
So what is a Tax Free Savings Account or TFSA? Like an RRSP this is a special account anyone 18 years of age or older with a valid Canadian SIN can open and contribute money to. The money in that account can be invested in stocks, bonds, ETFs, etc. and you pay no tax on any of the gains, interest, and dividends you earn while the money is in that account.
This sounds fine so far but the biggest benefit comes when you want to withdraw the money in your TFSA. Your withdrawals are 100% tax free! That includes the new growth in your account after your initial deposit.
So let's say you originally contribute $10,000 to your TFSA. You invest that money into stocks, bonds, ETFs etc and that original $10,000 grows to $50,000. Now when you withdraw the $50,000 that entire amount is tax free! Even though you technically only paid tax on that $10,000 you contributed. This is because all that growth happened inside a tax sheltered account.
It's important to note that just depositing money into this account isn't what's going to help you. Even though it's called a 'savings account' it's really an investment account. Investing the money in your TFSA is what allows you to take advantage of its benefits.
Okay now we are talking! But there is a limitation to how much you can contribute to this account.
Contribution Room
Your contribution room is dictated each year by the Canadian government and it is the same for all Canadian residents over the age 18 of regardless of your income or any other factors.
You can see the table which shows the contribution limits from 2009 when the TFSA program started to 2023.
If you have unused TFSA contribution room, that unused room carries forward year to year and your new contribution room is added each year. So if I turned 18 in 2016 and I never contributed to my TFSA I would have $47,000 of contribution room in my TFSA in 2023.
(5,500 + 5,500 + 5,500 + 6,000 + 6,000 + 6,000 + 6,000 + 6,500)
Over Contribution
If you go over you contribution limit there is no grace amount. You will need to withdraw your excess contributions as soon as possible and file form RC243. There is a 1% penalty per month on the excess amount for each month you were over the limit just like with an RRSP over contribution.
TFSA accounts are great for short to medium savings goals. This is because unlike an RRSP, when you withdraw money from your TFSA you get the contribution room back the following year.
Let's say that I have $20,000 in my TFSA and $5,000 of contribution room. In 2023 I take out $15,000 to pay for a wedding. Now I have $5,000 in my TFSA and $5,000 in contribution room. However, when the clock strikes midnight on new years and it becomes 2024 my contribution room will be restored and I'll have $5,000 in my TFSA and $20,000 of contribution room.
In this way TFSAs are more flexible than RRSPs because you get the contribution room back after you withdraw from your account. In combination with your RRSP they become a very strong tax free retirement strategy with the ability to grow your money tax free, tax free withdrawals and more flexibility with withdrawals because you get your contribution room back.
Have fun handing out candy,
Laura
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