The Tax Free Saving’s Account (TFSA) is AWESOME!
Taxes are the biggest expense for most people. If you are a Canadian and either haven’t heard of a TFSA or don’t understand them fully, please do yourself a favour and read this article. If might just make you a millionaire.
Let’s start with an example. Imagine you want to save money for a downpayment on a home. You’re 25 years old and intend to buy a home 10 years from now. You put $50,000 for the down payment into an index fund that returns and average of 8% per year.
Not considering inflation, that would net you a cool extra $57,946 just for having your money sit there! Now that you’re 35 and ready to buy a house, you take that $107,946 out of your account and…
Without even asking for permission the government takes exactly:
$11,589
Leaving you with only: $96,357
Here is a chart of what that would look like. Your cumulative growth as if you were not taxed, vs as if you were taxed:
Welcome to capital gains tax. In short, if you sell any stocks in Canada for a price higher than you bought them for, the government considers that as income and takes some of it for themselves. It is taxed at exactly half the rate of regular income tax from working a job, but still, kind of stings. (For this example I was assuming that at 35 you’ve established yourself a high paying job qualifying you for a cool 40% income tax bracket, meaning your capital gains tax rate is 20%. So 20% of 57,946 (your profit) is 11,559.
But what if you could have kept that 11 grand instead? After all 11 grand is 11 freaking grand!
Turns out you can! In 2009 the government of Canada made TFSAs a thing. a TFSA or Tax Free Saving’s Account is an account that you can open with any financial institution like a bank (e.g. RBC), investment brokerage (e.g. Questrade) or insurance company (e.g. Manulife) where you don’t pay tax on any of your capital gains!
So in the example above if the money was initially put in a TFSA, you would have got to keep the full $107,946! (And then likely dumped it on a ridiculously overpriced house, but that’s a discussion for another day 🫣)
The REAL Power of a TFSA
Let’s say you want to use your TFSA to save for retirement instead. Imagine we live in a crazy world where students in Canada actually learn about the TFSA in high school and have enough money to put in the maximum allowable amount each year starting from age 18 until 65. If you put your money against the same index fund that returns an average of 8% per year, at age 65 you would have:
$4,077,382
If you took out 4% of that money each year (often sited as the”safe” withdrawal rate, leaving the other 96% to grow) That is enough to give you an income of $163,095 per year, FOREVER (even if you lived to 500). Without paying a penny of that in tax!
Scenario 1
What if you had invested that money in a “normal” account instead? The amount of tax you’d have to pay on an income of $163k 47 years in the future is impossible to predict. But even if your income was taxed at 15% you’d still be throwing over $24,000 down the drain each year (or $2000/month) by not taking advantage of the TFSA.
Scenario 2
What if, when you are 65 you want all that money right away. If the money was in a TFSA you’d get all of it. If the money was in a “regular” taxable account, selling $4 million in investments would put you in the highest tax bracket (around 50%). Considering this would be capital gains income let’s say you are taxed at 25%, you would have to immediately give over $1 million to the government! In this case, the TFSA literally saved you a million dollars!
Let’s have a little fun
$7,677,685
Welcome to your infinite tax free income of $307,107 per year.
And just for fun what if you were able to hold off taking out your money for 5 more years until you were 70? This is how much you would have:
$12,471,480
Or a pretty damn sexy $498,859 infinite tax-free income. That’s $41,571 per month. Even with inflation that’s huge!
And this isn’t even considering any other sources of income you may have such as an RRSP, your CPP payments, taxable investments (for when your TFSA is maxed out, more on this shortly), sale of a house etc.
Realistically, you’re likely going to want to use the money in your TFSA earlier than age 70 or 65, and that is ok. I just want to first get you inspired with what is possible if you take full advantage of such an underrated tool that you have at your disposal.
The Rules
- You must be at least 18 years old to open an account (there is no maximum age!)
- You are only allowed to put in up to a certain amount each year. $5000 per year in 2009 inflation adjusted to the current year rounded to the nearest $500. In 2023 that amount is $6500
- If you over contribute you will be taxed on the excess amount at a rate of 1% per month, or 12% per year (please do NOT do this)
- If you withdraw the money in your TFSA you will be allowed to put in the same amount on next January 1st (plus that years new allowed contribution limit), but NOT before that
- You are allowed to invest the money in your TFSA in pretty much anything such as stocks, bonds, GICs, cash (please do NOT use it as a savings account unless you know you want to use it for very short-term savings)
- You are allowed to have multiple TFSA accounts, but you must make sure the combined total does not exceed your total allowed contribution room
- You are not allowed to day trade in a TFSA. The definition of day trading in this case is not 100% clear, but you best be assured if you trade a stock 100 times in a single day, your account it going to be flagged
- You must be a resident of Canada and have a valid SIN
Those are the main rules to know off the bat. There are more nuanced specific rules and you can find them all out here: https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/rc4466/tax-free-savings-account-tfsa-guide-individuals.html
The Rules, but Detailed!
1. You must be at least 18 years old to open an account
While, you must be at least 18, every single Canadian should learn about the TFSA before they turn 18, so when they turn 18 they can open one with confidence.
A bit of nuance: If for example you turn 18 on September 14th 2023 (works for any day of the year), then you will be allowed to open an account starting on September 14th 2023 but not before. However, considering the TFSA contribution limit for 2023 is $6500, you will have all $6500 of room available to you. So you can open an account on your 18th birthday and immediately put in $6500 if you so choose. (And then another $6500 as early as January 1st 2024)
2. You are only allowed to put in a certain amount each year
Here is a chart with the contribution room for each year starting in 2009 when the TFSA started in Canada:
| Year | Amount |
|---|---|
| 2009 | $5000 |
| 2010 | $5000 |
| 2011 | $5000 |
| 2012 | $5000 |
| 2013 | $5500 |
| 2014 | $5500 |
| 2015 | $10,000 |
| 2016 | $5500 |
| 2017 | $5500 |
| 2018 | $5500 |
| 2019 | $6000 |
| 2020 | $6000 |
| 2021 | $6000 |
| 2022 | $6000 |
| 2023 | $6500 |
Yeah for some reason in 2015 the government was extra generous.
Age Example 1
Let’s say you turned 18 in 2006, that means in 2009 the year you turned 21 you would have had access to the TFSA in the first year of its existence and you would have been allowed to put in $5000 on your birthday. Then on January 1st 2010 you would have received an additional $5000 of contribution room bringing your grand total to $10,000. Each year your contribution room would have accumulated so that in 2023 you would have been allowed to put in a total amount of $88,000.
Age Example 2
Now let’s say you turned 18 in 2019, and you opened your account on or shortly after your birthday, all within 2019. You only would have been allowed to open an account on or after your birthday in 2019. When you opened your account in 2019 you would have received the $6000 contribution room. You would have subsequently received more contribution every year until 2023 when you would have accumulated a total of $24,500 of available contribution room in 2023.
But what if you turned 18 in 2019 and it is now 2023 and you haven’t opened a TFSA yet. If you open one today you’ll get the full $24,000 of contribution room right away. Nice.
More nuance: In 2016 the government must have realized the $10,000 they allowed in 2015 was too much so in 2016 they put the limit back down to $5,500 and tied all future contribution limits $5000 in 2009 money adjusted for inflation. For example $5000 in 2009 would be worth roughly $6,642 in 2022. For TFSA contribution room, round it to the nearest $500 to get $6500. Thus this makes the added allowed room for the next year, 2023, be $6500.
3. If you over contribute you will be taxed on the excess amount at a rate of 1% per month, or 12% per year
Let’s say you turned 18 in 2023 and you opened a TFSA shortly after your birthday in 2023 and you put in $10,000 right away. That means you just over contributed to your TFSA by $3,500 since the limit for 2023 is only $6,500. As long as that excess $3,500 is sitting in your TFSA you will be taxed 1% of this money, or $35 every month. That will cost you $420/year. In short, that is a waste of money, please do NOT over contribute. Keep careful track of all your contributions.
A word of caution about re-contributions in the same year. If for example you put in the full $6,500 in 2023 right away, then you take out $3,500, then put that $3,500 back in all before January 1st, your account will look like it has only $6,500 in it but according to the CRA you would have put in $10,000 (the $6,500 initially put in PLUS the $3,500 you put in at the end). The contribution limit only looks at what you put IN, not what you take out. In this case you will be taxed the same huge 1% per month. So be extra careful when taking money out of your TFSA that you don’t cumulatively put in more than the allowed limit.
It is very important for you to keep track of how much money you put IN to your TFSA. Nobody is going to baby sit you and count each contribution for you. The CRA will give you an updated (and usually outdated) TFSA contribution limit once per year, but that’s it. All the intra-year contributions will need to be tracked by you.
This is something to keep in mind, BUT in the reverse, the withdrawl rules are actually pretty nice…
4. If you withdraw the money in your TFSA you will be allowed to put in the same amount on the next January 1st, but NOT before then
Similar to the point above, this one is actually pretty sweet. Let’s say you have a maxed out TFSA with $50,000 sitting in it and you want to use it to help pay for a downpayment on a house or a God awfully expensive wedding or whatever. You can take out all $50,000 without penalty AND you will be able to put the $50,000 back in the TFSA as early as the next January first PLUS the additional contribution room you get each January 1st.
In a ridiculously extreme example you could take out the $50,000 on December 31st and then put it all back in plus your $6,500 additional room to have $56,500 in your account the next day on January 1st. I have no idea why you would want to do that, but hey, you can without penalty, so there you go.
5. You are allowed to invest the money in your TFSA in pretty much anything such as stocks, bonds, GICs, cash etc.
I won’t get into depth here (there will be other articles for that) but a TFSA basically just an account to put money in that has specific rules. You can (and 99% of the time should) invest the money you have inside your TFSA in securities such as stocks and bonds. Any and all growth from investments that occur inside a TFSA will be tax-free. This is where you’re going to get those millions of dollars I was alluding to earlier.
This is not official financial advice, you can do whatever you want with your money at the end of the day, but I really would recommend that the majority of people invest the money inside their TFSAs in broad Index funds or ETFs (exchange traded funds). Which are basically a collection of stocks, bonds, GICs packaged into one that tend to have less fluctuation in price than single stocks. These things would charge management fees, but most of the fees are very low, around 0.1% – 0.03% of your portfolio value per year.
What YOU specifically invest in will be up to you and this article will not help you choose. Though there will be many future articles related to ETFs and Index funds and the like. Bottom line here is please do figure out which securities are right for you to invest with and then invest in them! If you don’t this will likely be the difference between your TFSA being $400,000 and $4,000,000 when you retire!
6. You are allowed to have multiple TFSA accounts
7. You are not allowed to day trade in a TFSA
Some people day trade, which is to make multiple trades of certain stocks within the same day with the hopes of making a quick buck due to the small fluctuations in the market that occur all the time. Buy low sell high! Quick!
If you do this enough inside your TFSA your account will be flagged and you’ll get in trouble. Please don’t do it. If you really need to day trade (I don’t really recommend it) then do it in a non-registered account.
8. You must be a resident of Canada and have a valid SIN
Let’s say you are 25 years old an you just moved to Canada from another country and now have a valid SIN and are a resident of Canada. You can open a TFSA but you will only begin accumulating contribution the year that you arrive in Canada and get your valid SIN number. So a 25 year old new resident to Canada in 2023 can only put in a maximum of the $6,500 contribution room for the year. Whereas a 25 year old who has lived in Canada since they were at least 18 and have had a valid SIN for just as long can open a TFSA and have access to $41,500 of contribution right away. For more information on residency related rules please refer to the Government of Canada website: https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/rc4466/tax-free-savings-account-tfsa-guide-individuals.html#P44_1111
Fluctuating contribution room
This is some important nuance! Once you have money in a TFSA and the money is invested in securities or even if it is in a savings account earning interest your contribution room will change. I will illustrate with some examples.
Example 1. Let’s say you your TFSA maxed out with exactly $50,000 and it is all invested in the next hot stock HOT.TO (not a real stock, just for the example). Let’s say you put all the money in HOT.TO on January 1st 2023. Then the stock exploded and on December 1st 2023 the stock is worth $200,000! You’re all excited so you take out all the money to buy a house or whatever. Now on January 1st you will be allowed to put in at total of $206,500! (the amount you withdrew plus the additional $6,500 of room everyone gets.
Example 2. Now in a different world, you also have your TFSA maxed out with exactly $50,000 and you make a grave mistake and put it all on a very bad penny stock NOTHOT.TO. For example if you put all the money on NOTHOT.TO on January 1st 2023, and then on December 1st 2023 your account is only worth $10,000. You sell all your stock of NOTHOT.TO out of fear it will go to $0 and take the money out of your account. Now on the following January 1st you will only be allowed to put in $16,500 into your TFSA! Again, this is the amount you took out (all of it) plus the $6,500 of room everyone gets.
These are extreme examples and I don’t anticipate either one happening to you exactly. But hopefully you now understand how the contribution room of a TFSA will fluctuate with the value of your holdings in it. The quick advice I would give here is NOT to put the money in your TFSA on risky penny stocks because the contribution room you get is extremely valuable and if you lose it it is very difficult and risky to get back. Either put the money in quality companies that have a solid track record of growth or better yet, broad low-fee ETFs and/or index funds and hold for the long term, at least 10 years. Again this is not official financial advice, but it is what I would personally recommend for the majority of people.
Conclusion
The TFSA is one of the most powerful financial tools that Canadians can take advantage of to build their long-term wealth. A detailed look at the rules and the potential of this account should be taught to all Canadians before they turn 18. If I new all this at that time I would have been at least $10,000 richer by the time I was 28, if not more.
The information presented here is not an exhaustive list of the rules of the TFSA, it is just meant to get you started and inspired about what one can do for you. As stated earlier, more rules and nuance can be found on the Government of Canada website: https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/rc4466/tax-free-savings-account-tfsa-guide-individuals.html
Lastly, I am not your financial advisor and I don’t intend to be. The information presented here is just meant to inspire, entertain and get you started on your wealth building journey. Your circumstances are unique so take this information in the best way it suits you. Also even though I have checked everything to the best of my ability, if you have found any errors in the above information please do give me a good roast in the comments or send me an email, especially in the winter, I could use the extra heat!
Now go rock your TFSA journey!
– Sean
P.S. The spreadsheets used to calculate the values in this article can be found here for your reference:
https://docs.google.com/spreadsheets/d/1HmWz92Qh6h3qfgr4txueC72BWDnCQTfq-dT0-KNTLZ4/edit#gid=0
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