Personal Investing: When Should I Open a TFSA (Tax-Free Savings Account)?
A Tax-Free Savings Account (TFSA) is a great way to save money and earn some tax-free investment income. But when is the best time to open one?
This guide breaks down everything you need to know along with these questions our clients popularly ask:
What are the benefits of a TFSA?
Are TFSAs good for long or short-term savings goals?
Is it easy to access money from my TFSA?
How do TFSAs make money?
Common mistakes of TFSAs
How risky are TFSAs?
How much can I contribute to my TFSA?
Before we dig in, we’re CC & Associates, a financial service provider helping women and families prepare for their futures and get their finances organized so they can make big purchases, save for retirement, and stop worrying about money.
Book a call with us here for 15-min a Q&A call, where we will answer any question you have about budgeting, investments, or insurance.
Now, let’s get into it.
What’s a TFSA, and what are the benefits?
TFSAs are investment accounts that banks and other financial institutions offer and are a powerful savings tool for Canadians over 18 years of age.
With a TFSA, you can earn tax-free interest, dividends and capital gains on your investments. This means the money in your account will grow faster because you don't have to pay taxes on those earnings.
Are TFSAs good for long or short-term savings goals?
In the short term, a TFSA can be an excellent place to save for a specific goal, like a vacation or a down payment on a house. Unlike other investment accounts, like RRSPs, you can withdraw from a TFSA without any penalties or taxes, so it's the perfect choice for anyone who needs their money quickly.
In the long term, TFSA contributions can add up, and the tax-free growth can be impressive. This makes it an excellent option for saving for retirement or other long-term financial goals. As a result, the longer you keep your money invested in a TFSA, the more money you will accumulate over time.
How do TFSAs make money?
TFSAs make money by investing your money in stocks, bonds, and other investments. If those investments have positive returns, your account will grow AND you won’t have to pay taxes on the money you earn.
This means you earn tax-free returns.
How much money can I contribute to my TFSA account?
Every year, the government determines how much Canadians can contribute to their TFSA. In 2023, it’s $6,500.
But here’s the catch, if you haven’t maxed out your contributions every year, you have every year’s limit since you turned 18 to catch up on.
That means if you have never contributed to a TFSA you can deposit a total of $88,000.
How much can I withdraw from my TFSA?
You can make as many withdrawals as you want from your TSFA, and the money you take out won’t be taxed as a part of your income.
The one thing to consider, is that when you take money out, you won’t be able to reinvest that same about in that same calendar year if it exceeds your contribution limit.
Example TFSA Contribution Limit
Georgina had $20,000 in her TFSA account in 2023. She contributed the maximum amount determined by the government, $6,500, and then withdrew $10,000.
Since she already contributed $6,500, she can’t add more in 2023.
However, in 2024, she will be able to contribute $10,000 in addition to next year’s contribution limit to reach her maximum.
Common mistakes of TFSAs
1. Over-contributing
The main mistake people make with their TFSAs is contributing more money than the allowable limit. The contribution limit for 2023 is $6,500, and if you exceed this amount, you will be charged a penalty tax of 1% per month on the excess contributions.
Example TFSA Penalty
Tami had a contribution limit of $6,000 in 2022. She contributed a lump sum of $6,500 in October 2022.
When Tami filed her tax return, she realized she had exceeded her contribution room by $500.
So, she had to pay a $130 penalty for the two months she was over her limit.
Here’s the math: $6,500 x 1% x 2 months = $130 penalty.
2. Saving cash in TFSA accounts with low returns or existing debt.
TFSAs are a great way to save for your future, but cash isn't the smartest choice. It may be growing tax-free, but you'll only earn a low return. Likely around 1%.
If you have debts it's always better to pay them off before anything else because the interest rates are usually higher than the one percent interest you will earn on your cash! Plus, if you're saving long-term, inflation could outpace 1% returns over time.
That's why bonds and stocks would be better options, depending on how risky you want to get of course.
3. Not diversifying investments.
Another mistake is not diversifying your investments. The money you put into a TSFA can be invested in the following ways:
Mutual funds
Guaranteed Investment Certificates (GICs),
Government bonds,
Exchange-Traded Funds (ETFs),
Stocks or held as cash
Putting all your money into one stock or bond can be a risky move, as there is always a chance that the value of that stock could drop suddenly.
It’s important to spread your investments across different asset classes to reduce the risk.