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The Tax-Free Savings Account (TFSA) is an increasingly beloved savings vehicle used by Canadians. It’s more flexible than an RRSP and can be used for various savings or investment goals: home, vacation, retirement or as a place to hold investments.

The TFSA program was first introduced in 2009. At that time just over one in five Canadian families contributed to TFSAs. Today, according to the most recent StatCan numbers, Canadian families’ TFSA participation rate sits at a record high of 39.4%, nearly doubling from its 2009 level. Individually, almost 52% of Canadians have a TFSA.

TFSA Basics:

Canadians who are 18 and older can open an account and set money aside tax-free throughout their lifetime.

• Contributions to a TFSA are not deductible for income tax purposes.
• Any amount contributed as well as any income earned in the account (for example, investment income and capital gains) is generally tax-free, even when it is withdrawn.
• On January 1, of every year, your annual contribution room resets.
• The 2024 annual contribution room limit is $7,000.
• The total cumulative TFSA limit is $95,000 if you were 18 years old when the program launched in 2009 (we will dig into the cumulative TFSA limit below under Mistake #2).

Let’s look at the best way to utilize this fantastic savings vehicle:

TFSA Mistake #1: Holding Cash and not Investments in your TFSA

One of the biggest criticisms of the TFSA when it was rolled out was the name. Financial experts complained that the ‘Savings Account’ part of the name was too simple for such an exceptional product, that truly did alter how Canadians saved.

Today, the name is still troublesome. Many Canadians still don’t know they can hold investments in their TFSA and not just cash. And holding investments versus cash in your TFSA makes quite a difference. For example, the Mawer Balanced A fund year-to-date return is 4.32%. Cash is around 1%.

Given the power of compound interest – on a $40,000 TFSA over 5 years you’re losing out on over $6,000 by holding cash – that’s a significant amount of money lost over time. As my editor, Andrew Willis emphasizes:

The TFSA is an ideal investment account, especially if you want the magic power of compounding interest. In fact, there is no other place you can grow your money tax-free, and also withdraw it tax-free.

TFSA Mistake #2: Overcontributing to your TFSA

If you over-contribute to your TFSA, you must pay a tax equal to 1% per month on the excess. One area that can trip Canadians up at tax time is annual contribution room versus cumulative contribution room.

Things to remember:

Annual contribution room is indexed to inflation, so it fluctuates. The 2024 limit of $7,000 is the same for all Canadians.

Cumulative contribution room has been built up since 2009 (if you were 18 years old or older at that time) and everyone’s number will be different because when the government tallies an individual’s TFSA cumulative contribution room they consider:

• the TFSA dollar limit of the current year
• any unused TFSA contribution room from previous years
• any withdrawals made from the TFSA in the previous year

You will find both of these numbers via CRA through My Account for Individuals, as well as request a TFSA Room Statement.

Mistake #3 Incorrectly Choosing a TFSA over an RRSP and Vice-Versa

The general wisdom is that if an individual earns less than $50,000 per year, contributing to a TFSA makes sense since the earner is sitting in the lowest tax bracket. Contributing to an RRSP and reducing taxable income won’t impact savings or lower the tax bracket any further.

For Canadians earning over $50,000, RRSPs may make more sense for tax and retirement purposes.

Of course, you can hold and contribute to both an RRSP and a TFSA in the same year, but it’s important to get the allocation correct to meet goals such as reducing taxes, saving for retirement, and saving for shorter-term expenses.