Common TFSA Myths

You may want to save up an extra $500 before year end if you plan on contributing the maximum to your Tax Free Savings Account (TFSA) again in 2019.

While still a few weeks away, the Canada Revenue Agency is expected to announce another inflation adjustment for the 2019 limit which would mean $6,000 of new contribution room, up from this year’s $5,500 limit. If approved, this would bring the total contribution limit to $63,500 for those who were 18 years or older in 2009 when the TFSA program launched.

It’s a little surprising that we’ve already had TFSA accounts around for a decade as they still seem somewhat new. It’s even more surprising that 10 years in, many Canadians still don’t understand how they work.

In anticipation of the next contribution limit increase, I wanted to take a moment to explain the biggest TFSA myths and misconceptions that still exist today:

1. A TFSA is a high interest savings account – This myth could not be farther from the truth. While many providers push TFSA investments in these savings accounts that pay little to no interest, this is not the only option. Stocks, bonds, mutual funds, GICs and many other investment options are all available inside a TFSA account.

2. A TFSA requires employment income – Unlike an RRSP, there is no employment income necessary to generate contribution room. Any Canadian over the age of 18 automatically gets the allowable contribution room for that year and you carry forward any unused room to future years.

3. A TFSA is a bank created product – While the big banks have done a great job in creating this illusion with aggressive advertising, the TFSA program is not their creation but is instead a program created by the previous federal government. As such, the TFSA vehicle is available from any licensed investment provider and not only used for the above-mentioned high interest savings accounts that the big banks promote.

4. A TFSA doesn’t require tax planning – While the growth of an investment held inside a TFSA is non-taxable, it does not mean that taxes should be ignored. Depending on the nature of your portfolio, it may make more sense to hold the higher taxed fixed income in your TFSA or you may be better to hold the higher potential growth equity portion. Proper tax planning is essential to maximizing which assets you choose to hold inside your TFSA account.

5. You can dip freely into a TFSA – You can in fact pull money out at any time, but you do need to be careful about re-contributing. If you’ve put in the maximum contribution amount and then make a withdrawal, you don’t regain that contribution room until the following January and putting the money back in before then will result in big penalties from the CRA.

6. A TFSA is better than an RRSP – Many feel that the TFSA is simply better since you don’t have to pay taxes on the withdrawals you make but they forget that you also don’t get a tax deduction for deposits like you do with an RRSP. Each situation is different, but most people’s best bet is to use a combination of RRSP and TFSA contributions.

When first introduced, TFSAs did not have a significant impact on many people’s overall portfolio as the maximum room was only $5,000 per adult. A decade later, a couple’s $127,000 of combined room can make a significant impact on their overall retirement or savings plans and my hope is that everyone is using this opportunity to their full advantage.