Episode #50: The Beginner's Guide To TFSAs
This episode is designed to be a complete beginner friendly guide to TFSAs. By the end of the lesson you’re going to know exactly how you can go and open your own TFSA account, feel confident depositing some savings into it, and understand how to start using this account to build your wealth.
What is a TFSA
TFSA stands for Tax Free Savings Account. This is an account for Canadians, and every Canadian should have one because it is an awesome first investment account. The name ‘tax free savings account’ is unfortunately misleading because a TFSA is meant to be used as an investing account, not a savings account. This means it’s an account that you can deposit your money into, and then you use that money to buy investments. And a TFSA account can hold all different types of investments like mutual funds, stocks, bonds, GICs, etc.
You are allowed to deposit cash into your TFSA and save it there, BUT if you do this you’re missing out on the TFSA superpower that makes it one of the best investment accounts for Canadians.
Benefits of a TFSA
A TFSA is what’s known as a tax advantaged account. This means that the government has granted this account tax superpowers in order to give Canadians a compelling reason to use this account to save and build wealth for their futures.
There are different types of tax advantages, and in the case of the TFSA it’s what’s known as a tax sheltered account. This means that when you put money into this account, it can no longer be touched by taxes. Which is pretty freaking amazing. You put your after tax dollars into the TFSA, invest your money so that it grows substantially, and you don’t have to pay tax on the money that your investments make within the account. THEN even better, when you take money back out of that account, you don’t pay tax on any of it. Not even income tax, all of the money you make and withdraw is tax free as long as it’s invested in Canadian investments.
Foreign investments can be taxed, but at a fairly low rate that might not be enough to deter you from still owning foreign investments in your account. What this means for you overall, is that a TFSA gives you an opportunity to save money, grow that money significantly through investments, take that money out to use for your life, and never have to pay tax on any of it. If your investments grow to millions of dollars within that account and then you use those millions of dollars to fund your life, you don’t have to pay tax on it.
So already it’s pretty cool that you don’t have to pay tax on the money that you make in your TFSA or on the money you withdraw from your TFSA. And, for those of you who have watched my RRSP episodes, the other benefit of a TFSA is that unlike an RRSP you can withdraw money from your account, at absolutely any time, without penalty. You even get to keep your contribution room most of the time, meaning you can put that money back in, invest it again, and keep on growing.
How to open a TFSA
Opening a TFSA is extremely easy. All you need is to be 18 or 19 years old depending on what province you live in, and your social insurance number.
From there, you have a variety of options for where you can open a TFSA. It’s really just a matter of personal preference where you open one. For example you could open one through a big name bank like RBC where you have access to in person branches and easy customer support. You could use an online bank like EQ Bank that’s easy for you to access online anytime and might have lower account fees in exchange for not having in person services. OR you could use an online brokerage like Wealthsimple if you want low fees and more self management.
It’s completely up to you where you open a TFSA, you can even hold multiple TFSAs which many people do, but I don’t necessarily recommend that because it can get confusing to keep track of money that you’re depositing and withdrawing, which we’ll cover in the next section all about depositing and withdrawing money from a TFSA.
Depositing and withdrawing money from a TFSA
Let’s start out by talking about depositing money into your TFSA because there are some rules you need to follow here. TFSA accounts have what’s called a contribution limit. This means that the amount of money you’re allowed to deposit into your account is limited. And this is to stop people from keeping all of their money in a TFSA sheltered from taxes, because our society does require that we pay some tax.
The TFSA account was created in 2009, and the contribution limit has started building from that year onward.
This graphic is from RBC
Here’s a chart outlining all of the TFSA contribution limits since the account began in 2009. You can see that on average the annual TFSA contribution limit has been between $5,000.00 and $6,000.00, and that the total contribution room that has been built up since the account started is $75,500.00. This means that if you were old enough to open a TFSA account in 2009, you now have $75,500.00 worth of contribution room in that account.
If you turned 18 anytime after 2009, then your contribution room started building from the year you turned 18. For example if you turned 18 in 2015, then you would have $44,500.00 worth of contribution room in your TFSA, that’s the annual contribution limit of every year from 2015 onward added up. Every year they release a new annual contribution limit at the start of the year, and this gets added on to the contribution limits of the previous years.
But What If Your Investments Have Grown?
Now remember I told you that your TFSA is supposed to be an investing account. This means that theoretically since you opened an account and started investing, the investments you’ve purchased have grown in value. This means that you might have more money in your account than the contribution limit, and that’s completely okay, that’s supposed to happen. The limit is based on your deposits only. It’s not based on the investment growth that’s happened in that account since then. If you can’t contribute to your TFSA every year that’s completely okay, and extra contribution space that you don’t use just rolls over to the next year.
How To Take Money Out Of Your TFSA
Now that we’ve talked about putting money into your TFSA it’s time we talk about withdrawing money from your TFSA. You’re allowed to withdraw money from your TFSA anytime, and you don’t pay tax on it. Additionally, any money that you withdraw from your TFSA is added back to your available contribution room the next year.
Let’s say you’ve been maxing out your TFSA contributions and have invested well so that your money has grown and you now have $100,000.00 in your TFSA today. You decide to withdraw $10,000.00 of that to help cover the downpayment on a home. That means you have $10,000.00 of contribution room newly available in your account, BUT you’re not allowed to put it back in right away. You have to wait until the start of the next year to put that $10,000.00 back in, in addition to the new contribution room that’s announced for that year.
If you’ve already maxed out your contributions and you put your withdrawn money back in during the same year, then you’ll be penalized for over-contributing to your TFSA. The penalty for overcontributing is 1% for every month that the excess money is in your account, which can add up significantly so you don’t want to do that.
Do NOT Daytrade in Your TFSA
Daytrading is the kryptonite to your TFSA’s tax sheltering superpowers. You don’t pay tax on the investment income in your TFSA as long as you don’t daytrade. If the CRA finds that you’re daytrading in your TFSA (this depends on things like your number of transactions and gains), then they will choose to treat your account as a business and you will be charged income tax on it. You don’t want to do this, it will cost you a lot of money that you could just be bankrolling instead.
Rules of Using a TFSA Recap
This is a comprehensive list of the rules you need to follow to use your TFSA properly.
To open a TFSA you need to be 18 or 19 years old depending on the province you live in, and have a social insurance number.
Even though it’s called a tax free savings account, this is actually an investing account. While you don’t have to invest the money you put in there, if you don’t you’ll be missing out on the huge benefits of a TFSA. So, buy investments in your TFSA, and remember that Canadian investments won’t be taxed at all, while some foreign investments will be.
Make sure that you stick to the contribution limits set out for the TFSA. If you’re not sure what your contribution limit is you can log in to your CRA my account page and your limit will be listed on your dashboard BUT this limit is only updated once a year and it might not be accurate if you’ve deposited or withdrawn money since the last time it was updated. Because of this it’s better to keep track of your own deposits and withdrawals so that you don’t accidentally over contribute.
Don’t over contribute. If you do over-contribute you will be charged 1% each month for the extra money that’s in that account. If you accidentally over contribute, just make sure you take the extra money out of your TFSA.
Don’t withdraw money at a loss. You can withdraw money tax free anytime, but if you withdraw at a loss you will lose that contribution room.
Do not daytrade in your TFSA account. Unless you want to lose all of the tax perks that your TFSA has to offer, don’t daytrade in this account. Ever. Nooooo daytrading! If you want to experiment with daytrading (not something I advise doing anyways) then make sure you open up a separate non registered investment account to play with. Don’t mess with your TFSA or RRSP ever!
As long as you stick to these 6 rules of using your TFSA then you’re going to have the chance to do very well for yourself financially through investments, without the government coming to collect any of your earnings from you. This can do HUGE things for you in the scheme of planning for your future financial freedom and retirement. It’s not every day you get to get paid and not have to pay any tax on it, so I highly suggest jumping on this TFSA, opening an account, and beginning to deposit and invest money into it over the course of your working life.
Now before I go there’s one more question that people always ask about TFSA’s and that’s should I put money into my TFSA or into my RRSP. I’m going to be releasing an episode soon that compares both of these accounts and walks you through a blueprint of how to decide which account is right for you to use at different points in your life, so make sure you subscribe and turn on the notification bell if you don’t want to miss that episode.
Linked Resources
Want to learn the first steps you should take you start managing your money? Take the quick quiz on the How To Adult School home page!
Want to learn more about managing your finances like an adult? Sign up for the free back to basics beginner finance course.
Instagram: How To Adult School on Instagram
Tiktok: How To Adult School on Tiktok
Youtube: How To Adult Show on Youtube
Podcast: How To Adult Show Podcast
NOTE: This page contains affiliate links that allow you to find the items mentioned in this episode and support the show at no cost to you. While this show may earn minimal sums when the viewer uses the links, the viewer is in NO WAY obligated to use these links. Thank you for your support!