Strategies for Contributing to a Tax-Free Savings Account

To help Canadians save and invest tax-free, the government created the Tax-Free Savings Account (TFSA). Once you're familiar with the guidelines, there are many ways to incorporate a tax-free savings account (TFSA) into your financial strategy in order to boost growth and reduce tax liability.

The Tax-Free Savings Account:

With a Tax-Free Savings Account (TFSA), you can put away money that you've already paid taxes on and watch it grow and compound tax-free. The funds are yours to withdraw whenever you like, tax-free. It's a fantastic way to put money away for the future and the present. It's not hard, but there are a few parameters you should know.

Vital factors to keep in mind when investing in a TFSA

If you don't follow these crucial TFSA rules, you could be subject to hefty fines when handling your investments.

Potential repercussions of over-contribution

A yearly increase in the maximum allowable contribution is set by law. For Canadians who turned 18 in 2009, the maximum amount that can be contributed to a TFSA between now and 2022 is ,500.

If you put in more money than the maximum TFSA allows, you'll have to pay a monthly fee of 1% of the overage until it's gone.

You may overfill your TFSA without meaning to if you ever:

  • The funds in your TFSA can be moved to a new financial institution by withdrawing them and then re-contributing them. (Permit the financial institution to make the TFSA transfer instead.)
  • If you max out your TFSA for the year, any withdrawals you make will be added back to your yearly limit the following year.

Additional Resources: Tax-Free Savings Account Contribution and Withdrawal Guidelines

Gains and losses on investments held in a Tax-Free Savings Account

Your TFSA contribution limit is unaffected by profits, dividends, and interest that you reinvest. Like income, capital losses do not enlarge your living quarters. Your TFSA contribution limits will not be affected by the value of your TFSA account's assets as long as the funds remain there.

The amount you withdraw from your TFSA (net of any gains or losses on your original contribution) will be returned to your yearly TFSA contribution limit the following year.

How to Hold a GIC in a TFSA » MORE:

Stop trading on a daily basis!

As long as the stock is listed on at least one stock exchange, you can hold it in your TFSA. All of your profits (interest, dividends, and capital gains) will be taxed as income if the CRA determines that you are engaged in day trading as a business.

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Contributions to a Tax-Free Savings Account

When opening a Tax-Free Savings Account (TFSA), most investors prioritize one of two account types.

  • A standard deposit account is a bank account that can be opened at any financial institution. Since this TFSA is tied to a specific financial institution, the client can only invest in the bank's HISAs, GICs, and mutual funds.
  • Broker-held, self-directed TFSAs give investors more freedom than those with bank-held accounts. A self-directed TFSA allows the investor to choose from a wide variety of investment options.

Options for Investing in a TFSA

Unlike stocks, bonds, or mutual funds, a tax-free savings account (TFSA) is not an investment in and of itself; rather, it is an account type that can hold investments of various kinds.

Financial assets that generate interest

In terms of growth, "slow and steady" best describes interest-bearing investments like GICs, HISAs, and bonds.

  • Benefits: Interest income is fully taxable if not placed in a tax-free savings account (TFSA), so using a TFSA to put that money away can reduce or eliminate your tax bill.
  • Cons: Slower long-term compound growth due to low gain potential. As another example, until the maturity date of a bond or GIC is reached, you will not have access to the invested funds.

To learn more about the best high-interest TFSAs in Canada, check out our recommendations.

Putting money into stocks and bonds from dividends and capital gains

Capital gains and dividend paying investments (such as stocks, ETFs, and mutual funds) tend to be more volatile than interest bearing investments. However, depending on the investment option, their performance improves over time.

  • In a tax-free savings account (TFSA), capital gains and dividends can grow tax-free over time, potentially producing substantial returns.
  • Negatives: If you need to access your TFSA quickly and your investments have declined in value, you may be forced to sell at a loss. Furthermore, the loss cannot be deducted from other taxable capital gains in the same way that it can be with non-registered investments.

Factors to think about before opening a Tax-Free Savings Account

Think of a Tax-Free Savings Account as an instrument in your financial arsenal. It has a variety of applications, some of which are listed below.

Plans for investments with a shorter to middle-term horizon

To the contrary of RRSPs, contributions to a TFSA are not taxed when they are withdrawn, and the amount withdrawn is simply added to the next year's TFSA contribution limit.

Investments in a tax-free savings account (TFSA) can be used for a wide variety of purposes, including but not limited to saving for a house down payment, a major life event such as a wedding or vacation, or even as an emergency fund.

Using a tax-free savings account (TFSA) for intermediate-term goals means foregoing the tax-free compound growth that results from investing for the long term.

Save for retirement

There are a number of benefits to using a TFSA to save for retirement. For instance, other income-based retirement benefits, such as Social Security or the Guaranteed Income Supplement, will not be affected by your eventual tax-free withdrawal in retirement.

Although you don't get a deduction for contributions to a TFSA, all of the growth in your account is free of taxation at the end of the year. This makes a TFSA arguably more tax-preferred than an RRSP. You can deduct contributions right away, but withdrawing the money (which has likely grown significantly) will result in a 100% taxable event.

» Know the distinction between a registered retirement savings plan and a tax-free savings account

Fiscal strategy

A Tax-Free Savings Account (TFSA) can be a useful tool in tax preparation. You can put money into a TFSA in years when your income is low (when the tax break from putting money into an RRSP would be smaller) and take it out in years when your income is high without incurring any tax penalty.

Income-based tax credits and benefits like GST/HST Credits, Canada Child Benefit, Canada Workers Benefit, and the Age Credit are unaffected by TFSA withdrawals because they are not considered income.

The ins and outs of having more than one TFSA

You are free to open as many TFSAs as you'd like, whether they're all with the same bank or spread out among several.

The benefit is that you can use each account for a different purpose. Investing for retirement over a long period of time would be handled differently than investing for a vacation over a short period of time. Having a tax-free savings account (TFSA) for each individual simplifies budgeting.

How quickly you need the money and for what purpose determine this. Depending on your financial situation and long-term objectives, a TFSA can serve a variety of purposes.

Your asset allocation decisions for your TFSA will be driven by your unique financial objectives. How long you plan to invest for and how much you're willing to risk both play a role in determining what Talk to a financial planner, investment expert, or robo-advisor if you have no idea where to begin.

Absolutely To minimize tax liability, Canadians should take advantage of tax-free savings accounts (TFSAs).

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