How to manage your Tax-Free Savings Account

The new cumulative contribution limit on a Tax-Free Savings Account is $41,000. Everybody should have a TFSA. TFSAs are the best thing offered to investors by the federal government since the RRSP. But we say that with one caveat: you have to use your TFSA properly.

When the Tax-Free Savings Account, or TFSA, was first made available at the beginning of 2009, it had an annual contribution limit of $5,000. And that $5,000 limit was adjusted each year for inflation, but with a little twist.

The legislation that created the TFSA stated that the $5,000 limit could only be increased in increments of $500, and only if the inflated value of $5,000 had gone up by at least half of that $500. Consequently, it was not until 2013 that the annual contribution limit for the TFSA was raised to $5,500.

Earlier this year, however, the federal budget increased the limit to $10,000 for 2015 and later years, with no further indexation for inflation.

Investors should also know that if they haven’t previously opened a TFSA, the prior years’ contribution limits have not been lost. That means if you open a TFSA for the first time now, your total maximum cumulative contribution room for 2015 is $41,000 (assuming you’ve been a Canadian permanent resident since 2009).

Best thing since sliced bread? Well, at least since the RRSP

We at Money Reporter think that TFSAs are the best thing offered to investors by the federal government since the RRSP. But we say that with one caveat: you have to use your TFSA properly. It should not be treated like a bank chequing or savings account where you can add to or withdraw money from it whenever you please.

For example, if you put money into a TFSA, and then you take it out again in the same year, you could be on the hook for taxes.

To put it another way, say your “TFSA contribution room” for 2015 is $15,000. That means you’ve accumulated $5,000 contribution room you haven’t used from previous years, plus your $10,000 annual contribution you can make this year. Now let’s say you use up your $15,000 contribution room by adding $15,000 to your TFSA now. Then let’s say you need to take $1,000 out of your TFSA in November. TFSA rules will penalize you if you put that $1,000 back into your account this year. You have to wait until next year. If you put it back this year, you’ll have to pay a tax penalty of one per cent a month on the excess amount you have contributed, i.e., one percent of $1,000 each month.

Though we recommend you use a TFSA, it’s no direct substitute for a chequing, or even a savings account really. It’s more of a long-term ‘permanent’ savings or investment account.

TFSAs are a handy place to put cash, of course. That’s because it’s tough enough to earn satisfactory returns on cash after inflation let alone after both inflation and taxes.

Use your TFSA correctly

A TFSA should not be viewed in isolation. Nor should it automatically be considered as a replacement for other registered accounts such as an RRSP. Rather, think of it as part of an overall financial plan that will help you reach your financial goals.

When the TFSA was first introduced, it was easy to view it as a place to park cash for short-term objectives such as saving for a car or a down payment on a home. Or you could just regard it as a handy place to keep your emergency cash reserves. After all, $5,000 doesn’t make a substantial investment portfolio.

Today, however, the total cumulative contribution room is now $41,000. That gives you more flexibility to use a TFSA for various purposes rather than a just refuge for emergency cash.

By all means continue to put cash in your TFSA for emergency purposes and short-term financial objectives. But if you have funds left over for other purposes, a TFSA can also help you achieve longer-term goals, such as a secure retirement. After all, in general, the more assets you can put into tax-efficient registered accounts, be they cash, fixed-income or equity securities, the better.


Money Reporter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846

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