In earlier instalments of this column, we looked at some ways to invest your money, including ETFs and GICs. In this issue, we’ll look at the tax-free savings account (TFSA), which, despite its name, can also be used for investing in stocks, ETFs, and GICs.
A TFSA is a registered savings plan that lets you earn investment and interest income without getting taxed. If you earned a dividend of $100 in a TFSA, you get to keep the full $100, whereas the same dividend earned outside a TFSA would be subject to tax. You can also withdraw the $100 dividend from the TFSA without getting taxed. With this in mind, the TFSA is most effective for holding higher-yielding investments, as you maximize the tax-free advantage. It’s important to note that only the income earned in a TFSA is tax free. You cannot deduct any contributions to a TFSA from your taxable income. To open a TFSA account, you need to be at least 18 years of age and have a valid social insurance number.
Two of the most important things to know about TFSAs are the contribution limit and the contribution room. At present, the contribution limit is $6,000 per year, and this limit accumulates. So if I did not put any money into a TFSA in 2021, I can contribute $12,000 in 2022. This is my contribution room. You can easily find out what your contribution room is by logging in to your CRA online account. Be sure to do more research to understand how the contribution room works, and stay within it, as there are penalties for over-contribution.
The TFSA is an extremely flexible tool; although it’s most effective for holding higher-yielding investments, it can also be great for saving for short-term goals. For instance, if you are saving to buy a car, you can keep your savings in a high-interest TFSA. That way, any interest you earn will not be taxed, and you can potentially reach your goal faster.
There is also no limit to how many TFSAs you can have, as long as the total contribution is within your contribution room. So you can have a TFSA with a brokerage specifically for investing in ETFs, and another one to save for a short-term goal.
Over the long run, the tax savings a TFSA offers on your investments can be very significant, especially as you graduate from college and start making a higher income and move into a higher tax bracket.