Remember to Max Out Your TFSA!

Another year is upon us, and with it comes more TFSA contribution room. After 4 years of annual contribution room being $6,000, in 2023, it was indexed up to $6,500. Below, we go through the history of the TFSA and address some of the information we believe is the most important.

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If after reading this post you would like to read more about TFSA’s, check out A Beginners Guide to The TFSA.

History of TFSAs

Tax Free-Savings accounts started in 2009, and originally had a $5,000 per year contribution limit. Anyone with a valid Canadian social insurance number and 18 years of age can open a TFSA. Even if you are considered a non-resident in Canada.

Since their inception, there have been several contribution increases, as is seen in the image below:

In 2023, everyone that qualifies for a TFSA will be entitled to an additional $6,500 of contribution room. The maximum that anyone is eligible to contribute is $88,000.

Below you can find a breakdown of contribution room by year:

A person is entitled to receive Tax-Free Savings Account contribution room in the year that they turn 18. For example, if someone turned 18 in the 2013 calendar year, they would be entitled to $68,000 as of January 2023. 

TFSA contribution room limit is indexed to inflation and rounded to the nearest $500. This was the reason for the increase in the 2023 calendar year. This indexation process takes place every year. It is likely that the 2024 contribution room will be $7,000.

There is a simple formula to calculate how much contribution room is available for a person at the beginning of each year: Unused TFSA contribution room to date + withdrawals from a previous year + new contribution room. 

Warning: make sure you do not over-contribute. Any over-contribution is penalized 1% per month until remedied. Income and growth do not count towards your contribution room, it only takes into account money you have put into your TFSA directly.

TFSA or TFIA?

Calling it a Tax-Free “Savings Account” is a little too simplistic in our opinion. When people think of savings accounts, we often think of our High-Interest Savings Account (HISA) at the bank. However, the capabilities of a TFSA are far more complex and beneficial.

For instance, in a HISA or daily interest savings account you are at the whim of the financial institution. They might advertise that their savings accounts have a rate of 2.25%. Well, not surprisingly, if you put money into that account, it will generate 2.25% of interest. If that is all you are looking for, then it might be a suitable fit for you.

On the other hand, with a TFSA, the type of investments you can hold is extremely diverse. According to Canada.ca, the list of eligible investments includes:

• Cash
• Guaranteed Investment Certificates (GICs)
• Mutual Funds
• Securities listed on designated stock exchanges
• Bonds
• Certain shares of small business corporations

With such a diverse investment selection, the returns generated can be completely different from person to person. Underlying investments can be personalized to fit the investor’s investment objectives, risk tolerance, time horizon, etc.

Even if you were happy with the 2.25% guaranteed return of the HISA, you would be better off using it inside a TFSA. Within the TFSA you can hold High-Interest Savings vehicles from many different institutions. At the bank or credit union, only in-house savings vehicles are available.

Secondly, by holding it in the TFSA the interest generated is tax-free. Using just a regular HISA, any interest generated must be reported on your tax return.

So why should you maximize your TFSA contribution room?

TFSA Withdrawals Can Be Re-contributed

All contributions and income earned in the account can be withdrawn tax-free at any time, and for any reason. Any withdrawals that are made from a Tax-Free Savings Account, can be re-contributed in the following calendar year. Conversely, withdrawals from a Registered Retirement Savings Account (RRSP) cannot be re-contributed and the contribution room is lost. 

For example, say Bill had maxed out his TFSA contributions in January of 2017 of $52,000. Bill did not contribute to his TFSA in 2018. However, In June 2018, Bill withdraws $12,000 from his TFSA. He leaves the account as is but is wondering how much he could contribute in 2023. Calculating his eligible contribution room for 2023 is done as follows: $36,000 (unused contribution room from 2018-2022) + $12,000 (withdrawals in previous year) + $6,500 (2023 contribution room) = $54,500.

You can also confirm your TFSA contribution room on your CRA profile. However, CRA can be a little slow in updating this information. It will not list any current year contributions and previous year contributions will likely not be added until the beginning of May each year. This means in 2023, you won’t see any contributions or withdrawals done in 2023, and 2022 transactions won’t be posted until May.

Just to reiterate, withdrawals can be re-contributed but only in the next calendar year, not during the year of withdrawal.

Furthermore, even when gains are withdrawn they can be re-contributed. Let’s say you maxed out your TFSA in 2020 and had lifetime contributions of $69,500. However, your investments have done well and the market value is $90,000.

Near the end of 2020, you decided to upgrade your car and withdrew the full $90,000. In 2023, your contribution room would be $108,500 calculated as follows; $90,000 (previous year withdrawals) + $18,500 (contribution room from 2021-2023).

Investment Gains are truly Tax-Free

Due to contributions to a TFSA being done with after-tax dollars, all contributed funds grow tax-free forever. Any income that is generated, whether realized or unrealized, will not be taxed while in the TFSA or when it is withdrawn. 

Even upon death, the full market value of your TFSA is received by your beneficiary or estate completely exempt from tax. 

Contributions/Withdrawals at Any Age or Time

Once a person turns 18 they are eligible for that year’s TFSA contribution limit. Contributions can be made at any time throughout the year (as long as no over-contributions are made) and can be made regardless of age. RRSPs, on the other hand, must be converted to RRIFs at age 71. At age 72, no additional contributions to RRSPs are allowed and you must begin to draw an income.

Withdrawals from a TFSA can happen regardless of age or reason and are completely tax-free. If a withdrawal is done from an RRSP, that contribution room is lost, and the withdrawal is claimed as taxable income in the year of withdrawal.

Due to the Tax-Free nature of withdrawals, TFSAs make for a great place to have your emergency funds. If a large purchase is needed, a withdrawal will not have any tax consequences.

We also recommend trying to max out your TFSA as early in the year as possible. This allows the most time for the funds to grow tax-free.

TFSA Withdrawals Do Not Count as Income 

Withdrawals from a TFSA, as noted above, are completely tax-free and are not classified as taxable income. However, withdrawals from an RRSP have a minimum amount of withholding tax levied at source and the withdrawal amount is added to your taxable income. 

Having withdrawals counted towards income is significant and should be carefully watched. When income surpasses a certain level during retirement, clawbacks are triggered on Old Age Security (OAS). Clawbacks to OAS in 2023 are triggered at the $86,912 income level. If net income is higher than $141,917, OAS is completely clawed back and reduced to zero.

Note that there is an exception to the OAS clawback ceiling. For more information on that here is a great article written by one of our colleagues Aaron Hector: OAS Clawback Secrets for the High-Net-Worth.

Conclusion

For most client situations TFSAs are the most tax-advantageous savings vehicle available. They offer the most flexibility with regard to unexpected withdrawals and don’t leave investors in an uncomfortable income tax position when they need the money the most.

If you would like more information on TFSAs or if you’re interested in starting to save, send us a message by filling out our Contact Form. It would be our pleasure to get to know you and your financial situation better.

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