Tax Free Savings Accounts (TFSAs) have been around since 2009 and are the best way to stash your cash without being taxed. Unlike RRSPs, TFSAs have the same contribution limit for everyone, they aren’t dependant on your income at all. TFSA contribution limits are based on inflation, and are rounded up to the nearest $500 so that the annual contribution limits have been:
- 2009: $5000
- 2010: $5000
- 2011: $5000
- 2012: $5000
- 2013: $5500
- 2014: $5500
- 2015: $5500
Which means that as of 2015, you can put up to $36,500 into your TFSA.
If you are going to take anything away from this post, know that TFSAs are not savings accounts, even though ‘savings account’ is in the name. This is important as there are many financial institutions that offer ‘high interest’ tax free savings accounts but are really just their regular 1% savings accounts with a tax-free designation. This is important because if you open a regular savings account, you will probably end up losing more money to inflation than you would get from interest on any savings account.
Like RRSPs, a TFSA is an account designation, it is not a savings account. This means your TFSA can be a mutual fund, savings account or investment account.
Why then are TFSAs called ‘savings accounts’? I have scoured the web looking for that answer, but haven’t found anything definitive, which leads me to think that financial institutions probably lobbied to make the name misleading so that regular savers would be confused into thinking that they can only use their TFSA as a low-interest savings account.
Unlike RRSPs, you don’t get any tax refund when you invest in your TFSA. But unlike RRSPs, you don’t get taxed at all when you withdraw funds from your TFSA. This means that you can invest $36,000 in the S&P500, double your money in 10 years and not pay any tax when you withdraw your $72,000.
Because there is no immediate tax-break when you contribute to your TFSA, you don’t need to contribute during tax season, unlike an RRSP. But, because you want to grow your money, and the S&P500 grows an average of 12.65% per year, you’ll want to put your money into a TFSA as soon as possible.
Any Canadian aged 18 or over can contribute to their TFSAs. Any unused contribution is carried over to the next year. This also means that a well-to-do family of 4 can fill out every ones TFSAs contribution limit, as long as everyone is over 18, which is one of the reasons why TFSAs (and RRSPs) are seen to benefit the better off more.
What’s more, you can withdraw any amount from your TFSA whenever you want and not be penalized. And whatever you withdraw, you can optionally put back. This includes any interest you’ve made so that if you somehow made an amazing investment with your TFSA and grew its value to $100,000, you could withdraw all of it and later on this year, put $100,000 back in. The worksheet to figure out TFSA withdraws and contributions can be found on the Canada Revenue Agency’s (CRA) website.
What to use up first, a TFSA or an RRSP? Because growing and withdrawing your money is tax-free with a TFSA, I strongly suggest you maximize your TFSA contributions before you get into your RRSP. If you have the money, you could use any refund from your RRSP contribution to max your TFSA.
The difference between TFSAs and RRSPs can be summed up as “An RRSP is primarily intended for retirement. The TFSA is like an RRSP for everything else in your life”