Investing for Beginners – TFSA Accounts

As a Canadian, there are many tax-exempt ways to begin investing like opening a TFSA account. Before we delve into the benefits of the TFSA, for those who live in the US, the TFSA is very similar to the Roth IRA as they are both Tax-Free accounts that allow you to accrue wealth without having to pay the government a cut of your profits through tax. You can also open a TFSA at any financial institution and you are now able to open an account online without ever needing to set foot in a bank.

The TFSA (Tax-Free Savings Account) was created by the Canadian government in 2009 as a tax-exempt registered account that offered Canadians a special tax benefit on any money that was held in the account. Within your TFSA, you are allowed to hold anything – cash, GICs, mutual funds, ETFs, stocks and bonds – and any income that you earn from your investments are tax-free even if you withdraw the money. What this means is that the earnings (through capital gain and dividends) are allowed to compound over the years tax-free and would be substantially worth more in the future than if you had kept the same investments in a non-registered, tax-paying account.

TFSAs were offered to all Canadians that were at least 18 years old in 2009 and through the years, as Canadians turned 18, they were allowed to open up their very own TFSA accounts. This means that if you were already 18 years old in 2009, today, you would have been able to have deposited over $69,500 total in your TFSA for tax-exempt gains. 

Now you might be wondering why people do not just invest all their disposable income into a TFSA and never pay taxes every again. The Canadian government, although trying to incentivize people to save, decided that to maximize their tax revenue and provide an incentive, put limits – maximum yearly contributions – that Canadians would be forced to follow while using a TFSA account. I have included these maximum contributions based on the year that you turned 18. Please note that if you were already 18 in 2009 your maximum contribution would be $69,500.

Based on the table above, if you were 18 years old in 2010 and you had never opened or contributed to a TFSA account, you would currently be allowed to put as a lump sum up to $64,500 into a new TFSA and you would not be required to pay taxes on that money ever again.

Also, you might be wondering why the TFSA yearly contribution limit fluctuates from $5,000 to $6,000 and even to $10,000 in 2015. On average, the Canadian government has kept the TFSA yearly contribution limit pegged to inflation. In 2015, there was a change in the Canadian government and to incentivize voters to vote for a specific party, that party increased the TFSA yearly contribution limit to help people save and to keep that political party in power. Once they were back in office, they brought the yearly contribution limit for TFSAs back to what it had been in the past and confirmed that it was just a single contribution increase rather than a new status quo. The contribution limit since 2015 has remained steady with the rate of inflation in Canada.

What happens if I invest more than my TFSA contribution limit? If you were to incorrectly add more money into your TFSA than you were allowed to based on your given age, you would be charged a 1% penalty fee each and every month until you withdrew the excess money from your TFSA account. As an example, if you could deposit a lump sum of $49,500 in your brand new TFSA and you mistakenly deposited $50,000 – an excess of $500 – than you would be charged 1% - or $5 – on the excess ($500) every month. This 1% would cost you $5 a month that would come directly out of your post-tax income until you took out the extra $500 from your TFSA account and brought it back to the amount that you are allowed to contribute.

One of the greatest benefits of the TFSA is that it is a tax-free way to compound and increase your money to help purchase the big expenses in your life. Since you can withdraw these funds from your TFSA as many times as you want and without ever incurring a penalty fee or taxes on the money, it is a great place to begin building your down payment for an apartment, a condo or even a house. Please note that although you will not need to pay any taxes on this money or any penalty for withdrawing this money, if you do decide that you want to put the money back into your TFSA after withdrawing it, you will only be able to replace the amount of money you withdrew in the following year. To explain this, if you decided to take out $10,000 from your TFSA in June 2019 because you wanted to put a down payment on a condo and, unfortunately, the condo is sold to someone else and you don’t end up purchasing anything, you would not be able to put your $10,000 directly back into your TFSA account until the following year (which would be January 2020). As this is the case, please keep this in mind if you ever decide to take money out of your TFSA.

Overall, there is absolutely no downside to a TFSA as it is extremely flexible for withdrawals without any penalties and it should definitely be the first account that you open once you have begun your investing journey. 

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