A Tax-Free Savings Account, or TFSA, is a bit of a misnomer. Yes, it’s an account, and if you really wanted to, you could fill it with cash and collect the paltry interest rate that a bank offers and it will function like an old fashioned savings account. But it’s preferable to think of a TFSA as a basket where you’re free to put a bunch of investments — stocks, bonds, ETFs, cattle futures — you name it.
What makes TFSAs different and super attractive is the “tax-free” bit; you won’t have to pay a cent of taxes on any gains that your investments make while sitting in the account. Ever! Unlike its cousin, the Registered Retirement Savings Plan (RRSP), contributions to TFSAs are not considered “tax-deferred,” so you’ll have to pay taxes on any money deposited into the account. But when you take that money out — and unlike the RRSP, you’re free to do whenever you’d like without penalty — you won’t have to pay any further tax on it regardless of how much your investment has grown.
The Canadian government introduced these handy little guys in 2009 as a way to encourage people to save money for retirement. They do, however, put some limits on their generosity. As of today, you’re allowed to deposit up to $5,500 per year, and should you accidentally exceed that, you will be charged a penalty of 1% per month on the amount in your TFSA that is in excess of the limit. On the flip side, whenever you don’t max out your TFSA, that unused contribution room accumulates and rolls over into the following year’s limit. And that rollover benefit applies to every year after you turn 18 years old, even if you’ve never actually contributed to a TFSA or only started doing so in, say, your 30s.
But should you need to withdraw funds at any time, not only will there be no penalty, the amount you withdraw is added to how much you can contribute the following year. Sound confusing? Let’s look at an example: say you withdraw $5,000 this year from your TFSA. Next year, you’ll be eligible to contribute the normal $5,500, plus an additional $5,000. Any Canadian resident over 18 years old, can — and really should — have a TFSA to enjoy as much tax-free growth as possible.