TFSAs (“Tax-Free Savings Accounts”) have turned out to be a really popular way for Canadians to invest. TFSAs were first introduced in 2009, and since then, over 13 million Canadians have opened one. In 2015, the most recent year for which data is available, around 60% of TFSA holders contributed to their TFSA (or in some cases, multiple TFSAs). Before we get started, we would like to note that if you have decided to open a TFSA already, we would suggest checking out our review of Questrade. Questrade is Stocktrades and Dan Kent’s broker of choice, and Dan has been a happy client of theirs for over 7 years. Feel free to email him with questions regarding anything Questrade!
Does the average income have anything to do with TFSA useage?
We also saw that having a TFSA isn’t substantially impacted by your income – 7% of TFSAs were held by Canadians declaring income of between $20,000 and $24,999, and 7% were held by those declaring income between $100,000 and $149,999. So, no matter what, if you have a TFSA, you’re not alone.
How many people are withdrawing from their TFSAs?
We were able to find data from the Government of Canada showing who made withdrawals from their TFSAs. We weren’t all that surprised to see that Millennials and members of Gen Y seem to withdraw the most. We’ll blame that on situational factors that mean that young people might have to dip into savings a bit more than they’d like. We did, however, find it interesting that the trend is continuously downward as TFSA holders get older. We expected TFSA withdrawal rates might rise or at least flatten among retirees. No matter what though, all this data tells us a lot about how Canadians use TFSAs.
Things you should know about TFSA withdrawal and contributions
We know that there’s a lot of confusion around TFSA contributions and withdrawals. In fact, because the rules are complicated, the Canada Revenue Agency (CRA) has not just had to clarify them more than once, but they actually had to change their policies so less Canadians would be fined for minor mistakes on withdrawals and contributions. This article is intended to provide a simple explanation of the rules around a TFSA withdrawal and a contribution. We’ll also discuss a few more or less related topics around TFSAs.
One side note: putting money into a TFSA is properly called a “contribution.” In effect though, it’s the same as making a deposit. If it’s easier for you, just think of a contribution as being a deposit. We’re going to use the word contribution throughout this article.
TFSA withdrawal and contributions – How much am I allowed?
Although we don’t suggest using a TFSA like a chequing account, you can actually make a TFSA withdrawal as often as you want. All the money you take out will be tax-free, including free of capital gains tax, except in some special circumstances.
Why don’t we suggest using your TFSA like a chequing account?
As we’ll see, the big mistake people make with TFSAs is over-contributing. If you’re depositing your paycheque to a TFSA and then paying your mortgage out of it, you’re very quickly going to over-contribute and be penalized by the CRA.
There’s another reason we would avoid using a TFSA for day-to-day spending: it means you’re not putting that money to work earning a return. Instead, you’re developing the habit of spending today what you should be saving for tomorrow. That could become dangerous in the long-term.
How often can I contribute to my TFSA?
As far as contributions go, you can contribute whenever you like. As long as you have unused contribution space of course. So don’t hold back – max out your TFSA whenever possible!
Consider using automated contributions. Your bank or financial institution will be able to help you set them up. If you’re investing in stocks, bonds, ETFs, etc. through your TFSA, you should be aware that the best research says that investors should never try to time the market. So as long as you have the money, the contribution space, and the investment still fits your portfolio, buy it as soon and as often as possible.
But – what’s your contribution space, and very importantly, how is it impacted by withdrawals? Read on…
You can withdraw as much money from your TFSA as you want. The bigger issue is, how much can you contribute?
As we said previously, TFSAs were introduced in 2009. At that time, they had a $5,000 contribution limit per year. The contribution limit was raised to $5,500 in 2013. This was implemented in order to keep pace with inflation. In 2015, Stephen Harper’s government increased the limit to $10,000. In 2016, Justin Trudeau’s government reduced the limit back to $5,500 again and announced that increases would once again be linked to inflation, with some rounding. At the end of 2017, your total TFSA contribution space is $52,000.
This means that if you’ve never had a TFSA, you can go ahead and open one and contribute $52,000 right now. But what if you had a TFSA, took everything out, and now want to contribute again? How much space do you have? Well, you still have $52,000 in contribution room. But there are rules to when you have contribute it.
Make sure you wait until the next year to contribute a TFSA withdrawal back into your account
Imagine it’s January 1, 2017. Because it’s a new year, you now have more TFSA contribution space. You contribute your maximum of $5,500 and now have $52,000 in total contributions to your TFSA (we’re ignoring any returns you’ve earned inside the TFSA).
On October 2, you go to the bank and withdraw $5,500. Is that $5,500 in contribution space lost? No – but the rule here is that you don’t get that space back until the next year! If you contribute another $5,500 on November 1, you’re technically over the contribution limit, and you’ll be fined.
Instead, wait until January 1, 2018. Not only will you have new 2018 contribution space ($5,500), but you’ll get the 2017 contribution space back (another $5,500). You can safely contribute $11,000 on January 1 without risk.
Get how TFSA withdrawals work? If not, here’s another example
On January 1, 2017, you contribute $3,000. On each of June 1, July 1 and August 1, you withdraw $1,000. How much contribution space do you have remaining until the end of 2017? Well, you already used $3,000. So even though you withdrew all $3,000, you don’t get that space back until 2018. You can only contribute $2,500 in the rest of 2017.
Imagine you contribute that $2,500 on November 1. You’re at your maximum for 2017. But on January 1, 2018, you get that additional $3,000 back – so on January 1, 2018, you can contribute $3,000 for 2017, plus another $5,500 for 2018.
If you made your full contribution in 2016, make no contributions in 2017, and then take out $2,000 on November 1, 2017, what happens?
Your contribution space for 2017 is now reduced by $2,000. You’ll get that space back in 2018.In short, any TFSA withdrawal you make will reduce your contribution room for that year. Why are these rules like this? We think it’s so you don’t treat your TFSA like a daily chequing account.
What are the penalties if I over contribute to my TFSA?
Any over-contributions are penalized at 1% per month of the highest over-contributed amount until they’re either withdrawn, or more contribution space becomes available (say, on January 1 of the next year).
1% per month is pretty steep – a $3,000 over-contribution in July will lead to a $30 penalty in all months following it until the end of December, if not corrected: $180 in total (6 x $30). So it makes sense to avoid over-contributing.
How do things like dividends and share price increases effect TFSA withdrawal and contributions?
So far we’ve mostly ignored the impact of investment returns on contributions and withdrawals. But here’s the interesting thing: gains on investments like dividends in TFSAs actually increase your future contribution room!
Imagine you had contributed $10,000 to your TFSA and bought a stock that doubled in price. You now have $20,000, and you withdraw it all. Although you’ve lost that contribution space for the year, next year you get to contribute the whole amount, not just the $10,000 you initially contributed!
However, this rule works both ways.
imagine you invest $10,000 in your TFSA and lose it all on a bad investment. That $10,000 in contribution room is gone forever. In fact, if you’ve never had a TFSA at all, it would be possible to contribute $52,000 on November 1, 2017, lose it all by December 31, and never get that $52,000 back. You’ll get $5,500 in new contribution space on January 1, 2018, but that $52,000 is gone forever.
This makes sense, as the CRA probably doesn’t want people making huge bets to earn big tax-free returns in their TFSA.
As an aside, at Stocktrades.ca we would never advise anyone to make any investment that could lead to a disastrous loss of return. Take the long-term view, not the short-term view.
Properly invest in your TFSA and this situation is unlikely to occur
This loss of contribution room only actually “crystalizes” if you make a withdrawal – so if you do see, say, a 10% decline in your portfolio value inside a TFSA, don’t panic. That contribution room is only gone if you withdraw. A properly-invested TFSA will probably see those losses regained over time.
Our final suggestion on this point: if you’re going to play risky stocks, consider doing it outside a registered account. That way you don’t impact your contribution room, and you get to deduct any losses from future capital gains.
Are there ways a TFSA withdrawal can be taxed?
Generally, returns inside a TFSA are tax-free. However, there is one exception we want to mention. Investments in foreign stocks might lead to “foreign non-resident withholding taxes.” For example, the US government might tax a dividend you receive from a US company before that dividend ever reaches your TFSA. The CRA isn’t taxing that money, but the US is.
Another time where a TFSA withdrawal might be taxable is when you happen to hold US citizenship. The US taxes its citizens on all their earnings, no matter where they live or reside for tax purposes. If this applies to you, talk to a professional before investing via a TFSA.
So how many TFSAs can I have?
There’s no rule saying you can only have one TFSA. You might find that having two TFSAs makes sense for you. For example, you might want to keep your rainy day emergency money in a high-interest TFSA product. These accounts are often offered by one of the big banks. But that might only be $10,000. What about all the rest of your total TFSA contribution space? You can easily have a second TFSA, even at a different bank or financial institution like a discount broker where you can hold stocks and bonds in your TFSA. As long as the total amount of money you’ve contributed to the TFSA is $52,000 (as of the end of 2017), you’re fine with having more than one TFSA.
This also means that it’s very important that you consider and track every TFSA withdrawal you make. A $3,000 withdrawal from your TFSA at one bank means you lose $3,000 of contribution room for that year in all your TFSAs. The best way to think about it is to view all your TFSAs as linked, and in fact, that’s essentially how the CRA will view them.
So who is contributing the max to their TFSA in 2018? What are you investing in and how well have they done? Let us know in the comments below, and thank you for reading!