Ever since the Tax-Free Savings Account (TFSA) was launched in 2009, many Canadians have used it as a general savings account. However, to make the most of a TFSA, it should be targeted to reach a specific financial goal.
Only when you identify a goal can you align your TFSA investments with your financial objective, time horizon and risk tolerance. These investments might change significantly over the years, as a TFSA can meet different goals throughout your life.
WHEN A TFSA EVOLVES OVER TIME
The variety of financial needs one TFSA can meet over the years is virtually endless. For example, say that someone in their 20s uses their TFSA to save for a car. After that goal is met, new investments in the TFSA help cover the downpayment on their first home. Then the TFSA supplements education savings for their child. Once the child is in university, they use the TFSA to save for their retirement. Finally, their TFSA helps to support their retirement lifestyle.
What makes a TFSA ideal for continuing to meet one goal after another is the opportunity to replenish every dollar you withdraw. Just remember to wait until the next calendar year to replace the withdrawn funds, unless you have contribution room available from previous years.
You might replenish the funds through a regular savings routine and by contributing larger sums when opportunities arise—such as if you receive an annual bonus or tax refund. Also, you can transfer investments from a non-registered account into your TFSA, but note that any capital gains on these investments must be reported and are subject to tax.
MEETING MULTIPLE OBJECTIVES AT THE SAME TIME
Most people are working toward more than one financial goal at any given time, each with its own time horizon and asset allocation. While some people use their TFSA to meet one goal at a time, others may use a TFSA or TFSAs to meet two or more goals simultaneously. When doing so, you need a method to separate each financial objective. It’s the only way to allocate the specific investments appropriate for each goal, monitor your progress and, ultimately, withdraw only the funds devoted to the particular goal.
Here are the options for meeting multiple goals simultaneously with one or more TFSAs.
Separate investments. Within one TFSA, you can earmark separate investments—whether they’re mutual funds, exchange-traded funds (ETFs) or individual securities—for each goal. For example, you could dedicate fixed-income investments to your next vacation, while equity investments create an emergency fund for your retirement years.
Multiple TFSAs. You are allowed to have more than one TFSA, and some investors prefer the clarity of having one TFSA for each goal. However, you must keep track of your contributions and withdrawals. Keep in mind that your limits are treated as if your multiple accounts were one TFSA.
Both spouses’ TFSAs. A couple can reach two different financial goals by applying each spouse’s TFSA to meet one goal. It’s a flexible approach. Say that one spouse’s TFSA is targeted toward a short-term need such as a bathroom renovation, and the other TFSA is devoted to retirement savings. Once the short-term need is met, the couple can redirect that TFSA toward the next short-term goal or toward saving for a medium-term or long-term financial goal.
THE INS AND OUTS OF A TFSA
Here are key rules for TFSAs, along with some additional helpful information.
- A TFSA dollar limit is set for each year ($6,500 for 2023).
- Contribution room begins upon turning 18 or from 2009, whichever is more recent.
- Contribution room is the total amount of the current year’s dollar limit plus any unused contribution room and unreplenished withdrawals from previous years.
- Investment choices include mutual funds, ETFs, stocks, bonds and guaranteed investment certificates (GICs).
- Overcontributions result in a penalty equal to 1% of the excess contribution every month until the excess is withdrawn.
- You can find your TFSA contribution room online at the Canada Revenue Agency’s (CRA’s) My Account, on the MyCRA mobile app or by calling the Tax Information Phone Service (TIPS) at 1-800-267-6999.
- Tax-free withdrawals can be made in any amount at any time.
- The amount of a withdrawal is added back as contribution room the following year.
- Note that many overcontribution penalties have resulted from replacing withdrawals in the same year.