The TFSA is a savings account or registered investment that allows you the opportunity to benefit from tax-free gains.
While you can use your TFSA for any goal that may come to mind, the annual contributions to a TFSA do have a limit (use our TFSA calculator here to figure out how much.) This downside may be acceptable when you consider that your withdrawals can also be made tax free.
The account type is one of the newer ones. It is often likened to the RRSP, and both are extremely important things to research in-depth and understand if you are learning how to buy stocks.
Accumulating contribution room with the RRSP requires you to have income declared. TFSA contribution limit begins to accumulate once you turn 18 years old. Your TFSA contribution is based on your contributions so far and the limit you have accumulated.
TFSA Contribution Limits Annually
The government sets TFSA limits, but it never sets them for too far in the future. For example, take last year's TFSA limit.
2019 had a contribution limit of $6,000 and the lifetime limit was $63,500. 2020 saw no difference in the contribution over the previous year.
However, the lifetime limit amount for 2020 is $69,500. It's not too hard to calculate the maximum amount that you can consider contributing to your TFSA. But, we've summed it up for you in a simple table anyways.
Annual And Cumulative TFSA Contribution Table
|wdt_ID||Year||Annual Limit||Total Room|
To calculate your contribution limit, first figure out the year in which you turned 18
This is critical, as it marks the year where your TFSA contributions will start. So looking at the table above, if you turned 18 in 2014, your contribution room will be all the "Annual Limit" dollar figures in the table from 2014 and on.
So, if we add them all up, a person who turned 18 in 2014 has a total of $44,000 of possible TFSA contribution room.
Next, take your total contributions made thus far to your TFSA
If you haven't made any contributions to your TFSA, your limit will simply be all the annual allowances since you've turned 18.
However, if you've made previous contributions, you need to make sure you subtract them from your total contribution amount.
So for example, lets say someone who turned 18 in 2014 contributed $5000 in 2014, and nothing since. Their total contribution room would be $44,000 - $5000 for a total of $39,000.
Finally, take your previous years withdrawals and your next years allowance and total it up
So, lets take the same scenario from above. You contributed $5000 in 2014 but needed to pull it out this year to buy a new car. How much will your TFSA contribution limit be in 2021? Well, it's actually really easy to calculate.
TFSA Contribute Room for 2021 = Previous Year Withdrawals + New Annual Room + Previous Room
So, if we assume the TFSA limit for 2021 will be $6000, the formula would be as follow:
$5000 + $6000 + $39,000 = $50,000
As you can tell, any previous year withdrawals from your TFSA don't get added back into your TFSA contribution limit until the next year.
Or, you can sign up for a My CRA account
The easiest, quickest and most foolproof way to check out your TFSA limits is to create a My CRA account. From there, you'll be able to see TFSA contribution limits, RRSP contribution limits, and more.
Keep in mind, this account is updated on an annual basis. So if you had $5000 in TFSA contribution room in 2020 and put that $5000 in, this won't be reflected until 2021. This is an important thing to consider so you don't over contribute to your Tax Free Savings Account.
If you can afford to, try to maximize your contribution room as much as you can, this will help you generate higher returns and stay ahead of inflation.
TFSA is called a tax free savings account because it gives Canadians the ability to generate tax free investment income.
If you're a resident of Canada and want more information on how this whole equation works, you should visit the Canada Revenue Agency (CRA) website.
TFSA Over-contribution Regulations
As the TFSA feels like an account with crazy growth potential, you may feel tempted to contribute as much as you can.
However, you want to avoid over-contributing as you expose yourself to a penalty. Once your TFSA contribution has gone higher than your maximum allowable, you are going to be assessed a 1% penalty.
Note that this is levied against the surplus amount. That penalty continues to be present until the excess is withdrawn, so withdraw it as soon as you can. This interest rate is charged on a monthly basis. So if you over contribute by $10,000, the penalty would be $100 a month until you've withdrawn the excess TFSA contributions.
The most common way Canadian investors run into trouble with this is having multiple TFSA accounts. If you have $69,500 in TFSA contribution room and 3 TFSA accounts, you're not allowed to have $69,500 in each. Instead, you will have to split the $69,500 between the three accounts.
TFSA Tax Potential
When people talk about the TFSA, they tend to focus on the contribution and withdrawal regulations.
However, the "tax-free" portion of the TFSA does have it's limitations.
You'll find several instances on the internet, and possibly opinions from friends or other investors, where they state the Tax Free Savings Account is tax-free regardless of what you do within it.
While 99% of the time your earnings in a TFSA are tax free, there are instances where you could face taxes.
Capital gains, dividends, and interest you may earn on your investments inside of a TFSA are typically not taxable. This premise applies whether you withdraw them or leave them in the account.
However, there is another scenario in which you may land yourself in hot water with the CRA, and thus have to pay taxes on investments inside of a TFSA.
This happens if you are caught treating the TFSA like a business account and day/swing trading within it. If the CRA believes you are using the Tax Free Savings Account as a business account, they will tax you accordingly.
And keep in mind, they won't charge you a typical capital gain tax, which is tax on 50% on the profits of your investment. They'll instead charge you tax on 100% of the profits made in your TFSA. And although they're charging you tax on gains, they still don't give you the option to claim a capital loss within a TFSA.
Opening a TFSA
If you want to be in a position where you can take advantage of the benefits of a TFSA, you need to start by opening a TFSA.
Once you are a Canadian who is at least 18 years old with a social insurance number (SIN), you can open one.
Once you have these things in place, all you need to do is find a financial institution like Royal Bank or Questrade and open an account.
You may need to provide a few more details and documents, such as your birth certificate or drivers license.
In any case, the process typically takes 10 minutes or less. Then you are off to the races to begin investing in things, including but not limited to, stocks, ETFs, index funds, mutual funds, etc.
How much Can I Put in My TFSA If I Have Never Contributed?
If you've never contributed before, it means your contribution room is equal to the lifetime maximum for that year. If you turned 18 in 2014 for example, tally up all the contribution room from 2014 onward to find your total room available in your TFSA.
What Is the Lifetime Limit for TFSA?
The lifetime limit on your TFSA contribution is subject to adjustment yearly. You can get more TFSA limits and contribution information from the CRA website.
However, if you were 18 years old when the TFSA first started, your annual room in 2020 is $69,500.
How Much Can You Put in Your TFSA in 2020?
As the CRA website indicates, the yearly limit for your TFSA contribution in 2020 is $6,000. Therefore, the amount you can put in equates to the difference between $6,000 and any contribution you may have already made for the year.
What Happens If I Exceed My TFSA Limit?
If you exceed your TFSA limit, a 1% penalty is charged against the excess monthly for the remainder of the year. You can mitigate this by withdrawing the surplus and filling out the required paperwork.