It is official! The New Year (2019) will bring with it a new annual limit for the Tax-Free Savings Account (TFSA) and an opportunity for you to save and invest towards your short- and long-term goals.
Unlike the registered retirement savings plan (RRSP) which allows you to save for retirement in a “tax-deferred” account, the funds you put into your TFSA are going to remain tax-free for life. That means the capital gains, interest income, and dividends* earned on your TFSA account are all yours to keep. That being said, the TFSA does not grant you upfront tax deduction privileges like the RRSP.
*Foreign dividends may be subject to a withholding tax.
When the TFSA was first introduced in 2009, the annual limit was pegged at $5,000, and has seen some growth over the years to the new $6,000 limit for 2019.
TFSA Annual Limit Over The Years (2009-2019)
The annual TFSA limit is indexed to track with inflation rates. Given that inflation has dragged along the bottom for the past several years, increases in the annual limit have been limited.
Starting at $5,000 in 2009, the annual limit has now grown to $6,000 in 2019. This means there has been a total of two increases that can be attributed to the inflation index (in 2013 and 2019). A one-time increase by the Conservative government to $10,000 in 2015 lasted just one year.
The table below shows the annual TFSA contribution limit starting in 2009:
If you were 18 years of age or older when the TFSA was launched in 2009, you now have a total contribution limit of $63,500 in 2019.
How Is The TFSA Limit Calculated?
As mentioned earlier, the government adjusts the TFSA amount based on inflation numbers for the year (aka the indexation factor announced by Canada Revenue Agency each fall). The resulting amount is then rounded to the nearest $500.
As shown below, indexing the $5,721 TFSA number we arrived at last year and using the updated 2019 indexation factor of 2.2% results in $5,847 (i.e. $5,721 x 2.2%). When you round up this figure to the nearest $500, it gives us the $6,000 for 2019.
What Happens When You Over-Contribute?
Contributing more than you are allowed to your TFSA will result in penalties. An over-contribution may occur because you forget your annual limit, or make a withdrawal and then go ahead to re-contribute it back in the same year. The penalty for TFSA over-contribution is a 1% per month penalty tax on the excess amount.
For example, if your total contribution room is $8,000 in 2019 (i.e. the $6,000 limit for 2019 and $2,000 carried forward from previous years), and you decide to contribute $10,000 to your account in April 2019. The excess $2,000 will generate a monthly penalty of $20 (calculated as $2,000 x 1%), or a total of $180 for the remaining 9 months of the year ($20 x 9 months) if you do not withdraw the excess contribution.
You may be eligible to request a waiver of over-contribution penalty from the Canada Revenue Agency. Read more on the TFSA over-contribution penalty here.
Some Options To Invest Your TFSA
There are many ways for you to save or invest your TFSA account. Depending on what you plan to use the funds for (short- or long-term goals), your options include:
1. High-Interest Savings Account
If you are saving your TFSA to fund a short-term goal e.g. vacation, wedding, car purchase, home down payment, etc., a savings account that pays you a reasonable interest may be the way to go. With this option, you can have peace of mind by staying away from the volatility of the financial markets, while expecting a “positive” return on your money.
One of the best high-interest savings account in Canada is:
Exchange Traded Funds (ETFs) are a type of index fund that trade like stocks on an exchange. Compared to traditional mutual funds, ETFs charge much lower management fees and can help you build wealth faster.
If you are a do-it-yourself investor, you can create your own diversified portfolio of ETFs using a self-directed brokerage account. My preferred online discount brokerage is Questrade and you can sign up here to receive $50 in free trades.
Alternatively, you can take a hands-off approach to investing in ETFs by using a robo-advisor. They do all the work and charge you a management fee that’s much lower (average 0.50%) than what you pay to your mutual fund managers (average 2.35% for equity mutual funds).
Sign up with Wealthsimple and invest up to $10,000 free for 1 year.
4. Stocks and Bonds
Your TFSA can hold a variety of stocks and bonds depending on your risk tolerance and risk objectives. A self-directed brokerage account is useful to buy stocks, bonds, and ETFs of your choice. Note that foreign dividends earned on your stocks may be subject to a withholding tax.
You can open a Questrade account to trade stocks, bonds, and ETFs. You get $50 in free trades with this link.
5. Mutual/Index Funds
Mutual funds are generally very expensive in Canada – our mutual fund fees are one of the highest in the world! That being said, you can easily buy mutual funds at your bank or credit union for your TFSA account.
Index funds are a type of mutual fund that are passively managed and have lower fees. If you are interested in index investing, check out my complete guide here.
Frequently Asked TFSA Questions
1) Can I withdraw money from my TFSA?
Yes, you can withdraw your TFSA funds at any time.
2) Do I lose TFSA contribution room after withdrawing funds?
No. Any amount you withdraw can be re-contributed without penalty. However, you will need to wait until next year before you can put back money you took out this year. You can also carry your contribution room forward to future years indefinitely.
3) Can I contribute to my spouse’s TFSA?
Yes, you can contribute to anyone’s TFSA account. Since you are using “after-tax” funds, the government doesn’t care and you are not allowed to claim a tax deduction for any monies put in a TFSA.
4) Can I contribute more than my TFSA limit for the year?
You can contribute your annual TFSA limit plus contribution room carried forward from previous eyars. if you exceed your total limit, you will incur a 1% monthly penalty on the excess amount.
5) What kinds of investments can I hold in my TFSA?
You can invest in almost any financial assets, including stocks, bonds, mutual funds, ETFs, GICs, and more. That being said, there are a few prohibited and non-qualified investments you should avoid.
6) Do I have to pay tax when I withdraw money from my TFSA?
No. TFSA means tax-free – that is no taxes on withdrawals, dividend income, capital gains, and interest income. Note that foreign dividend-bearing stocks may result in some tax-withholding (e.g. 15% for U.S. dividends). Also, you cannot claim a capital loss.
7) Can I contribute more than my TFSA limit for the year?
You can contribute your annual TFSA limit + contribution room carried forward from previous years. If you exceed your total limit, you will incur a 1% monthly penalty on the excess amount.
8) What happens to my TFSA when I die?
You can designate a beneficiary (anyone) or a “successor holder” (spouse or common-law partner) to receive your assets. Read more about TFSA beneficiary designations here.
9) Can I transfer my TFSA from one bank to another?
Yes, this is easy to do and you should not incur any taxes or penalties. However, you usually have to pay your bank a transfer fee. Read more on how to transfer your registered accounts between banks here.
10) Can I have more than one TFSA account?
Yes. You can open as many TFSA accounts as you wish. However, you need to ensure your contributions do not exceed your total contribution room.
11) Which account should I contribute to? TFSA or RRSP?
It depends. I have written a detailed guide on how to choose between a TFSA vs. RRSP here.
- Everything You Need To Know About TFSA’s
- How To Buy a Home With Your RRSP
- When To Prioritize TFSA over RRSP
- 5 Ways To Invest Your TFSA
- How To Generate Retirement Income From a RRSP