TFSA limit rules can be confusing. Follow along as our expert, Adeola, a CPA, clears up Quinn’s confusion (along with ours) around TFSA contribution limits.
The question…
I’m starting to think about taxes for this year and realized there’s one thing in particular that I just don’t know how to wrap my head around. Last year I took some money out of my TFSA. How does that affect my contribution limit and taxes this year? I’ve been trying to read up about it, but seem to keep coming across conflicting info.
Quinn F., Halifax, NS
The answer…
Great question Quinn! Thank you for asking.
A tax-free savings account (TFSA) is one of the best savings and investment tools Canadians have. If you haven’t started using your TFSA, there is no better time to open an account than now.
What is a TFSA?
The Canadian government introduced the TFSA in 2009. They sensed that Canadians needed a little push to save more. Even though the TFSA is called a savings account, it is indeed an account you can use to invest and build wealth.
To open a TFSA, you must be 18 or older. In some provinces like British Columbia, you may need to wait a little bit longer, until 19, before you can open a tax-free savings account. You also need to be a resident of Canadian to enjoy the tax benefits from the TFSA.
TFSAs are a way to invest in allowable financial assets. The Canada Revenue Agency (CRA) emphasizes that Canadians are only permitted to invest their TFSA savings in certain assets such as:
- Stocks
- Bonds
- Exchange-traded funds (ETFs)
- Mutual funds
- Real estate investment trusts (REITs)
- Guaranteed investment certificates (GICs)
If you’re wondering whether you can buy digital assets such as cryptocurrency or non-fungible tokens (NFTs) in your TFSA, the answer is — not quite yet.
The catchy benefit of the TFSA is the tax-free component of the account. The Canada Revenue Agency does not tax your dividends or capital gains earned.
Even if your earnings are as much as $50,000, you pay no taxes, which is really amazing.
The TFSA contribution limit
An account that has such great tax benefits surely has guidelines. One of the most important things to note about your TFSA is the contribution limit.
Every calendar year, the CRA assigns a TFSA contribution limit, which is usually rounded up to the nearest $500. For 2022, the TFSA contribution limit is $6,000. Here is a breakdown of the tax-free savings account contribution limit in previous years and the limit for 2023.
| Calendar Year | Annual TFSA Dollar Limit |
| 2009 to 2012 | $5,000 |
| 2013 to 2014 | $5,500 |
| 2015 | $10,000 |
| 2016 to 2018 | $5,500 |
| 2019 to 2022 | $6,000 |
| 2023 | $6,500 |
The CRA pegs the TFSA limit to inflation. This means that as the cost of living increases, the Canadian government also increases the TFSA contribution limit. Due to inflation rates being significantly high in 2022, the Canada Revenue Agency increased the TFSA limit to $6,500.
If you are not able to use up your TFSA contribution room in a particular year, you do not have to worry about losing your savings opportunity. You can carry forward your unused TFSA contribution room.
The TFSA limit not used in any year accumulates. For example, if you didn’t make any contributions in 2022, because we are now in 2023 you will have a contribution limit of $12,500. The sum of $6,000 for 2022, and $6,500 for 2023 is available to you.
Be careful not to contribute over your TFSA limit, as this can lead to tax penalties. The CRA taxes over-contributions to the tax-free savings account at 1% for every month the excess amount remains in the account.
Withdrawing from your Tax-Free Savings Account
You can withdraw from your TFSA at any time, and you can use the money from your TFSA for any purpose. Feel like taking a vacation or replacing your car, and you have enough money in your TFSA? It is all yours to use. You can even save for retirement using a tax-free savings account. However, unlike a Registered Retirement Savings Plan (RRSP), you can not claim your TFSA contributions as a tax deduction.
When withdrawing from your tax-free saving account, you need to know that there may be delays or fees associated with withdrawals from your TFSA. For example, investing in fixed-term assets, like GICs, that require locking in for a year, you may need to pay some fees to withdraw your money. Always speak to a financial advisor when you purchase financial assets through your TFSA. That way you’ll be sure to understand the terms and conditions involved.
Also, if you buy financial investments in your TFSA, such as stocks, you may not be able to convert your assets to cash readily. For example, during periods when the stock exchanges are closed. In that case, you or your financial institution may need to place a sell order and wait for your financial assets to sell before you can withdraw cash.
Another thing to note is that investing can be risky. You may make capital gains or losses depending on the volatility in the financial markets.
How your withdrawals impact your TFSA contribution room
Now to cover the question of how your withdrawals from your TFSA affect your contribution limit.
When you withdraw from your TFSA in a given year, you will get your contribution room back up to the amount you withdrew. However, you need to wait until the following year to get your tax-free savings account limit restored. Remember, you do not pay any taxes on your withdrawals.
Using this very simple example, this is how your withdrawals can impact your TFSA limit.
Assume you became eligible to contribute to a TFSA in 2022 with a $6,000 TFSA limit, and you used up your entire $6,000 contribution room by May 2022. Down the line in the year, in July, you realized that you needed to buy a flight ticket for $3,000, so you withdrew this amount from your TFSA.
If you receive a bonus payment from your job sometime in November, and you have a spare $3,000 to save, you cannot contribute this amount back to your TFSA. Your withdrawal did not free up space for you to contribute more to your tax-free savings account in 2022. You had exhausted your contribution limit by May.
The $3,000 contribution room becomes available to you again by January 2023, the following year from 2022.
Another example is If your investments in a TFSA lose value, you will not get the loss as additional contribution room. For example, suppose you contribute $4,000 to your TFSA, and you buy stocks with the total amount. If the value of your stocks decreases to $2,000, that does not create an additional $2,000 room for you to contribute to your TFSA.
Remember, the penalty for contributing over your TFSA limit to a tax-free savings account is a 1% tax rate on the excess amount. To avoid paying taxes, ensure you keep track of your TFSA limit and withdrawals.
Opening a TFSA account
You can open multiple tax-free savings accounts, but having too many TFSAs can make you lose track of your contributions and TFSA limits. You need to be a resident of Canada and provide a social insurance number when opening a TFSA.
Your financial institution can manage your TFSA investments for you. The other option is opening a self-directed tax-free savings account.
With a self-directed TFSA, you can buy and sell financial assets yourself and rebalance your investment portfolio. In essence, you get to manage your TFSA investments. It is recommended to use a self-directed TFSA only if you have investment knowledge and expertise.
Key takeaways
- A TFSA is a great account for Canadians to save and invest.
- You must be 18 or older to open an account.
- If you are eligible to contribute to a tax-free savings account, you will have an annual contribution limit.
- The dollar TFSA limit is generally indexed to inflation.
- If you are not able to contribute in any year, you can carry your unused TFSA contribution room forward.
- Your TFSA withdrawals do not enable you to contribute over your annual TFSA limit. Your withdrawal amount room only becomes available to you again the following year from the year you made the withdrawal.
- Any income you earn through your TFSA is totally tax-free. There are no taxes on your dividends or capital gains earned.
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