TFSA Pros and Cons: Know All the Facts (2024)
So, you’ve decided to open a TFSA account. Good for you! TFSAs can be a great way to save money. You can use it to save for big purchases, pay down debt or cover emergency expenses.
40% of Canadians contribute to a TFSA. But before you start stuffing dollars into your TFSA, it’s important to understand what it is, and the pros and cons of these tax-free savings accounts.
In this post, we’ll take a look at the TFSA pros and cons.
Highlights:
- You can contribute up to $6,000 per year (for 2022), and any unused contribution room from previous years can be carried forward
- Income earned in a TFSA is not taxable
- Contributions are not deductible for income tax purposes
- Withdrawals are not taxable
What is a TFSA?
A Tax-Free Savings Account (TFSA) is a type of Canadian registered account that allows you to save or invest money without having to pay any taxes on the money you make from it.
What does “registered account” mean? Registered accounts offer tax sheltering or tax deferral benefits, as opposed to “non-registered” accounts, which are fully taxable.
- TFSAs are tax-sheltered, as the name implies and in most cases, gains are tax-free.
- RRSPs are tax-deferred as withdrawals are taxed as income.
The TFSA is not an investment in and of itself, rather it is an account to hold different investment vehicles such as stocks, ETFs, mutual funds, GICs, bonds, etc. Once your TFSA is set up, you still need to choose what to invest in.
Eligibility Criteria
TFSAs exist since 2009, the criteria to open an account are any Canadian who is at least 18 years ago and has a valid Social Insurance Number is entitled to the cumulative annual contribution room.
Contributions
If you’ve never contributed to a TFSA and were at least 18 years old when the program began, you have a total of $88,000 of contribution room.
Contributions to a TFSA are not deductible for income tax purposes, and any income earned in a TFSA is not taxable. The unused contribution room can be carried forward and used in subsequent years.
The holder of a TFSA is not subject to tax on the withdrawal of funds from the account, regardless of the amount withdrawn.
Pros
- Tax-free growth
- You can withdraw money from your TFSA at any time for any reason
- Your TFSA can be used for different financial goals
- Contribution room never expires
- Helps to grow your family’s wealth
Cons
- Certain prohibited investment
- Withholding tax on foreign income
- Contributions do not lower taxable income
- No creditor protection
Pros of Having a TFSA
A Tax-Free Savings Account (TFSA) is a savings account where you don’t have to pay taxes on the interest you earn, which can make it a more profitable place to save.
Here are some of the key pros of having a TFSA:
1. Tax-free growth
A Tax-Free Savings Account (TFSA) is a savings vehicle that allows you to earn tax-free investment income. This is one of, if not the biggest advantage associated with a TFSA.
Tax-free growth means that any money you save in your account will compound at a much faster rate than it would in a regular savings account. But it’s not just the income that’s tax-free. Any capital gains, dividends, and interest generated from your investments will also be tax-free.
For example, if you invest in stock and it doubles in value, holding it in your TFSA means you wouldn’t have to pay any capital gains tax on your earnings. Plus, if this stock pays out a dividend, you wouldn’t be taxed on that either.
This makes TFSAs an ideal place to hold dividend-paying stocks and a powerful savings vehicle for Canadians of all ages.
2. You can withdraw money from your TFSA at any time, for any reason.
TFSA withdrawals can be a great way to access your money whenever you need it. Unlike an RRSP, there are no penalties for early withdrawal – meaning you can take out your money at any time, for any reason.
This also includes any income earned on investments made within your TFSA. So if you decide to take out money that you’ve invested in stocks or mutual funds, you won’t have to pay tax on that income.
Benefits such as Canada Child Benefit, Employment Insurance, Old Age Security and Guaranteed Income Supplement and potential tax credits won’t be impacted as your TFSA withdrawals won’t be included in your income tax return.
Finally, withdrawing money from your TFSA is a very easy process – you can do it online, over the phone or in person at a branch.
3. Your TFSA can be used for different financial goals
A TFSA can be used for any goal you have in mind, whether it’s long-term or short-term.
Your TFSA can be used as an emergency fund. If you ever have an unexpected expense, you can pull money out of your TFSA without penalty. This is a great option if you don’t have a rainy day fund set up yet.
For those of you who are looking to buy a home, the TFSA could be your go-to savings account.
One of the biggest benefits of the TFSA is that you can access your money at any time without penalty, making it a great option for those unexpected costs that always seem to pop up when you’re buying a home.
TFSAs are also great for extra retirement savings since the income generated within the account does not impact government benefits.
Lastly, don’t underestimate the power of the TFSA for goals such as saving for starting a side hustle or even a well-deserved vacation.
4. Contribution room never expires
One of the biggest benefits of a TFSA is that your contribution room never expires and accumulates. This means that you can keep contributing, even if you’ve withdrawn funds in the past.
Let’s say you contributed $5,000 to your TFSA in January, but then you withdrew that money in March because you needed it for a down payment on a house.
You can put that $5,000 back into your TFSA at any time as long as you still have contribution room left. You can keep contributing and withdrawing money from your TFSA as long as you have contribution room remaining.
However, there is one exception to this rule. If you’ve already contributed the maximum amount to your TFSA for the year, you can’t re-contribute any more money.
If that’s the case, then you’ll have to wait for the following year to get this contribution room back.
Your TFSA contribution room is also not determined by your income or your age. This means that adult high-income earners and low-income earners can both contribute the maximum amount each year.
5. Grow your family wealth
Did you know that you can contribute to your spouse’s TFSA? Even if your spouse doesn’t have any income of their own?
It’s true! If one spouse has a higher income, that spouse can contribute money to the other spouse’s TFSA without the income earned being attributed to the higher-income spouse. This is a great way to help build family wealth.
Cons of Having a TFSA
As great as the TFSA is, there are a few cons to consider.
1. Prohibited Investments
A Tax-Free Savings Account (TFSA) is a great way to save money, but there are some restrictions on what you can and can’t do with the account.
The biggest restriction is that you can’t use your TFSA to carry on a business. This includes day trading, which is when you buy and sell stocks or other securities within the same day.
You also can’t use your TFSA to invest in certain types of securities, such as options or futures contracts. Similarly, you cannot use margin in a TFSA.
2. Withholding Tax on foreign income
Many people stash their cash in a TFSA to avoid paying taxes on the investment income. Did you know that if you hold U.S. stocks in a TFSA, the government will take 15% of the dividends you receive?
This means that, unless you’re willing to pay the withholding tax (and give up part of your investment returns), you’re better off holding Canadian stocks in your TFSA.
Keep in mind that you will not be able to claim any tax credit for US withholding taxes on stock held in your TFSA.
3. Contributions do not lower taxable income
TFSA contributions are not tax-deductible, unlike an RRSP. This means that your taxable income will not be lowered by the amount of your contribution, as it would be with an RRSP.
For high-income earners, this may mean that the tax savings from contributing to an RRSP are greater than those from contributing to a TFSA.
However, unlike RRSPs, withdrawals from TFSAs are not taxable, which may be more beneficial for low and middle-income earners who are in a higher tax bracket during retirement than they were when they made their contributions.
4. No creditor protection
One downside of a TFSA is that it doesn’t have creditor protection. This means that if you go bankrupt or get sued, your creditors could technically seize any money you’ve saved in your TFSA.
This is in contrast to an RRSP, which does have creditor protection, except for deposits within the last 12 months.
Whether or not creditor protection is important to you depends on your personal circumstances. If you’re worried about protecting your savings, then an RRSP may be a better option for you.
How to Open a TFSA
So, you’ve decided you want to open a TFSA. The next step is to open one! Here’s how:
First, you need to find a TFSA provider, which can be most banks, financial institutions or online brokerages.
Once you’ve found a provider, you’ll need to provide some information, such as your Social Insurance Number and date of birth and sign an application form.
Next, you’ll need to decide on the amount you want to contribute. It’s good practice to check your contribution room with the CRA before making any deposits. This way you can maximize your TFSA and ensure you are not penalized for over-contributing.
Finally, you’ll need to decide on the investment options you want for your TFSA. These could include GICs, stocks, ETFs, mutual funds, etc.
Once you’ve opened your account, you can start contributing and watching your savings grow!
TFSA Traps to Avoid
There are a few traps to avoid when setting up and using your TFSA. Here are a few of the most common ones:
1. Not using the full contribution limit: This is one of the biggest mistakes people make with their TFSA. Make sure you’re taking advantage of the full contribution limit to get the most out of your account.
2. Not investing: Another common mistake is not investing in your TFSA, which can limit its growth potential. Make sure you’re taking advantage of all the options available to you within your TFSA to get the most out of it.
3. Not re-investing returns: When your investments start making money, don’t forget to re-invest those returns back into your account. This will help your money grow even more over time.
4. Withdrawing money too often: While it’s important to have access to your savings, try to avoid withdrawing money from your TFSA too often. This can reduce its overall growth potential.
5. Not keeping track of contributions: Finally, make sure you’re keeping track of your contributions so you don’t go over the annual limit and face penalties
Conclusion
So, there you have it—all the pros and cons of TFSAs. As you can see, there are some definite benefits to using a TFSA, but there are also some drawbacks. Whether or not a TFSA is right for you depends on your circumstances.
To maximize your hard-earned dollars, check out How To Pay Less Tax In Canada: 12 Little-Known Tips