Luisa Rollenhagen is a journalist and investor who writes about financial planning for Wealthsimple. She is a past winner of the David James Burrell Prize for journalistic achievement and her work has been published in GQ Magazine and BuzzFeed. Luisa earned her M.A. in Journalism at New York University and is now based in Berlin, Germany.
There’s a reason anyone with any sort of financial sense cautions against squirrelling away your money in cash under a metaphorical mattress. You’re more likely to spend it; it’s not protected against inflation, and it’s not accumulating any sort of interest. So how can you ensure the money that you worked hard for - now works hard for you?
That’s where the Tax-Free Savings Account comes in. It’s an account where any income earned in that account—whether that’s through interest-earning savings, ETFs, bonds, and stocks—are tax-free. It’s a great way to save. But what happens when you want to withdraw all that money you’ve been saving?
The main reason people withdraw from their TFSA is because you can do so without getting hit with a penalty or nasty withdrawal taxes.
A lot of people withdraw from their TFSA when they retire or encounter another major life event like a wedding or buying a home. Taking money from your TFSA allows you to delay withdrawing from your RRSP—which would be taxed. Retirees can also take out money from their TFSA without it affecting certain retirement benefits like Old Age Security.
Another reason why you might want to withdraw from your TFSA is that any amount you withdraw now will be added to how much you can contribute the following year, so it’s an easy (and again, tax-free) way to up your permitted contributions per year.
Whatever your reasons are, a TFSA helps you achieve short-term and long-term savings goals. Plus, it's an efficient flexible savings plan; if there’s an emergency and you need quick access to your money, the TFSA is there for you.
TFSA Withdrawal Rules
If you're not a fan of rules, you're in for a treat. There's few withdrawal rules when it comes to TFSAs. For the most part, you can take money from your TFSA as you like.
While there’s no penalty to withdrawing money from your TFSA, you’ll get taxed if you exceed your contribution limit. The government limits how much money you can put into a TFSA every year.
Contribution room automatically accumulates every year, but every time you add money to the TFSA, it goes into your allotted contribution room for that year. When you withdraw, on the other hand, that same dollar amount is added on top of your annual contribution room for the next calendar year. Unused contribution room also carries over into the next year.
It’s also important to know that you will accumulate TFSA contribution room for each year even if you do not file an income tax and benefit return or open a TFSA.
So let’s say the annual contribution maximum is $5,000. You’ve contributed the maximum each year without withdrawing anything until May 2017, when you withdraw $10,000. That means that next year, in 2018, your contribution room will be $15,000.
However, going over your annual contribution room will get expensive. Once you take the cash out, you can’t put it in again for that year if it’s going to push you over your contribution limit. Let's say your annual limit is $5,000 for 2017. You withdrew $10,000 in May, and then in November, you inherit $3,500, which you put into your TFSA. Problem is: you'd already contributed $2,500 in February of that year. That means that you’re $1,000 over the limit. That $10,000 is only added to your contribution room for the next calendar year, ie. January 1, 2018.
To sum up: Your TFSA contribution room is made up of:
your annual TFSA dollar limit
any unused TFSA contribution room from the previous year
any withdrawals made from the TFSA in the previous year
You can find out what your contribution room is through the Canadian Revenue Agency or through the financial institution holding the account.
TFSA Withdrawal Limit
You can withdraw from your TFSA anytime you want and take out as much as you like. The sky's the limit! Keep in mind that you can’t contribute over your TFSA limit, even if you make a withdrawal during the year. (This is one of the most common TFSA mistakes that people make.)
You start off each year with a certain set contribution limit. During that year, you can only reduce from your contribution room as you add money to the account. Any money you take out will gain you more contribution room, but only in the next year.
TFSA Withdrawal Fees & Penalties
Unlike RRSP's or other some other tax advantaged accounts, there’s no penalty for withdrawing money from your TFSA. The only withdrawal fee you might get hit with is one from your financial institution. Some financial institution will charge you a fee to withdraw or transfer your TFSA to another provider. The only time you'll get a penalty is if you ignore your contribution room and over contribute to your TFSA.
What happens if you do go over your contribution room? You’ll have to pay Canadian Revenue Agency 1% of the highest excess TFSA amount in the month, for each month that the excess amount remains in your account.
So let’s go back to our earlier example, which has you at $1,000 over your contribution room in November 2017. You’ll get taxed 1% of that, so $10 for each month that the excess amount is in the account for that year (assuming no other contributions or withdrawals are made that year). In order to avoid getting taxed on the amount, you’ll have to withdraw the entire excess amount.
TFSA Withdrawal Tax Implications
Although your TFSA is also good for short-term savings, you’ll get the most use out of it if you allow your cash to sit there untouched for a longer period of time, since your tax benefits will be larger the more you save. It’s also particularly useful to put your highest-income earning investments in your TFSA since you’ll be saving more on taxes.
It’s prudent to save your TFSA withdrawals for a time when you expect your tax bracket to be higher during retirement. Because the money has already been taxed, your tax bill won’t increase when you withdraw from your TFSA (as opposed to your RRSP).
But watch out: if you have foreign stocks in your TFSA, you may be subject to a foreign non-resident withholding tax. Make sure you understand the corresponding withholding tax rates for the foreign stocks you’re dealing with. Also: Any income generated by foreign stocks will still affect your contribution room.
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