What is a Tax-Free Saving Account (TFSA)?

The Tax-Free Savings Account (TFSA) was introduced in 2009. The account can let anyone above the age of 18 enjoy tax benefits that can help accumulate significant wealth without paying the Canada Revenue Agency (CRA) a single penny on the income gained in the account.

However, the CRA will keeps a close watch on these accounts to catch you if you make any mistakes. While the TFSA can let you enjoy tax-free wealth growth, it comes with certain rules and regulations you need to comply with to enjoy the tax-free status. Failing to comply will allow the CRA a chance to collect tax, which they will gladly do.

How can they do that you ask ?

• Over-contributing

Canadians that make the mistake of disregarding the maximum contribution limit in their TFSAs. The government introduced a limit to which you can contribute to your TFSA each year. The government increases the contribution limit annually, and with the 2020 update, the maximum contribution limit for your TFSA is now $69,500. That means if you have never invested in a TFSA since its inception, you can contribute $69,500 in cash or equivalent assets to the account in one lump sum.

Unfortunately, there are some Canadians that have made the mistake of contributing a lot more to their TFSAs than they should. The CRA charges you a penalty of 1% on the excess amount you hold in your TFSA each month. You can effectively lose the tax-free status of your account by making this mistake.

• Trading too much in the account

Another more common mistake you never want to make with your TFSA is using it as a day-trading account. Yes, you can use the TFSA to hold assets equivalent to $69,500. However, you can’t use the tax-free status of your TFSA to make trades for the short-term gains. If you plan on using the account for day trading, you can expect the CRA to take action as it was never intended as a tax-free way to trading stocks. If considerable money is made by day trading The CRA can consider any account used frequently in trading stocks to have taxable income, and will subsequently consider this a trading account and not a TFSA.

There is no definitive limit to how many trades you can make in your TFSA in a year, but you should not act as a day trader with the account. Ideally, you should use the account to buy and hold long-term investments. If you were to buy a stock which pays an annual divided and keep it in your portfolio for the long term then this is seen as a tax-free investment as you are allowed to investment in the stock market. 

What is the advantage of the TFSA?

Think about this you have $69,500 that you are able to investment in any funds or stock that you would like and under the Umbrella of a TFSA that can grow to a value much greater than your original investment. Let’s assume that this money grows by 6% on average during the next 15 years… plus with the additional moneys the government lets you deposit annually without penalty. You could have in excess of $382,251 of tax-free savings depending on the type of investment you choose. This is tax-free money and can be withdrawn without taxation which would make this another piece of the puzzle to consider in your retirement planning portfolio.

How did we get here?

Start with $69,500

Added.      $90,000 = $6,000/year for 15 years

Total Inv.  $159,500 x 6% (on average over 15 years) 

Total Value $382,251

The numbers are based on a continued estimate of what the government will do moving forward, the government has the ability to raise or lower the TFSA deposits allowed moving forward so we have estimated the present-day value moving forward for 15 years. If we take into account the compounding interested on money invested through deposits over 15 years our simple calculations @ 6% on a yearly average for a moderate investment you could grow this account to $382,251 of Tax-free Savings. 

Note:

We made this very general in the nature of simple math so we could show the effects of compounding interest. There will be years above and below 6% growth on your investment but we chose to look at an average rate of return throughout the 15 years of investment for the simplicity of explanation.