Every Canadian resident aged 18-plus can currently invest up to $6,000 in a TFSA every year and pay no tax on any increases in their investments’ value. So, if your investments earn interest, receive share dividends or increase in value (known as capital gains) you won’t pay a penny in tax, even when you sell those assets or withdraw money from the account.
If you’ve been saving in a TFSA since it started in 2009, you could now save thousands of dollars in tax every single year. So, those tax savings remain in your investment account, enjoy compound returns, and ensure that your savings grow much faster than in a non-registered account. The TFSA is kind of a big deal.
And it’s about to become an even bigger deal. While the TFSA contribution limit has remained stagnant over the last four years, it will increase to $6,500 in 2023 (by an extra $500). And while that may not seem like a huge increase, over time it can make a big difference to your overall investment savings. Let’s look at how the TFSA works, why it can be such a crucial retirement savings tool and what next year’s TFSA contribution limit increase could mean for your savings.
How the TFSA works and how much you can save tax-free
The TFSA is a registered investment account where your money grows on a tax-free basis and withdrawals are never included in income. However, there are limits to how much you can contribute to this account.
Unlike the RRSP, the TFSA contribution limit isn’t based on earned income — it’s the same for every Canadian resident aged 18-plus, even those who earn no money. When it was launched in 2009, the TFSA annual limit was $5,000. Parts or all of that limit can be carried forward to the following year, if not used or if withdrawals are made.
Unlike with an RRSP, where you lose the contribution room when you make withdrawals, any money you take out of a TFSA can be added to the following year’s TFSA total contribution amount. Your current TFSA contribution limit is therefore equal to:
The TFSA contribution limit for the year
plus
Previous withdrawals (other than withdrawals for excess contributions)
plus
Previous unused contribution room
As with tax credits, deductions and income tax brackets, the TFSA contribution limit is protected from inflation, as per an inflation indexing calculation, as defined in the Income Tax Act, which is rounded to the nearest $500. The Consumer Price Index (CPI) for the previous 12-month period is used in the calculation. The TFSA contribution room in 2022 is $6,000.
According to StatsCan, the September 2022 CPI 12-month change was 6.9%. This creates an indexing amount of $6,551. When rounded to the nearest $500, the TFSA contribution limit for 2023 will therefore be $6,500. Find out why it’s really important not to over-contribute.
Anyone who was aged 19-plus in 2009 and who has never contributed to their TFSA will therefore be able to contribute up to $88,000 in 2023.
Why the TFSA is such a big deal
We’ve already discussed a huge benefit of the TFSA — tax-free investment growth and withdrawals. The benefits don’t stop there, however. Used wisely, the TFSA has several other advantages.
A more tax-efficient retirement plan:
To have a well-balanced retirement plan, it’s essential to have some funds you can draw from that aren’t considered income (and therefore are not taxable). While RRSPs and company pensions benefit from tax-deferred growth, you will pay tax when you make withdrawals.
A recommended retirement strategy is to aim for a consistent level of taxable income every year. Canadian personal taxes are based on marginal tax brackets — these are defined as the level of tax on the next dollar of income you make. The consequence of marginal tax brackets is that when taxable income increases, taxes rates increase accordingly.
Fluctuations in taxable income in retirement can lead to more tax over the long term, rather than maintaining a consistent taxable income level. This strategy becomes easier if you can cover some expenses with money from your TFSA. It means you don’t have to resort to removing additional RRSP savings or withdrawing from investments that are in non-registered (and therefore taxable). This makes the TFSA an essential part of good retirement planning.
You can maximize tax savings with a contribution to your spouse's tfsa:
You can contribute to your spouse’s TFSA so they can also enjoy tax-free growth. Contributions to a TFSA held in your spouse’s name will not count towards your own TFSA contribution limit, so your family can effectively double the amount of TFSA tax savings.
TFSAs can make for more tax-efficient estate planning:
When someone dies (with no surviving spouse), the CRA considers their assets to have been sold at their full market value on the date of their death (even if no money changes hands) — this is called a deemed disposition. Increases in the value of some of those assets are considered income.
This can therefore bring about the largest tax bill of the deceased’s life. However, since the withdrawal of assets from a TFSA are not considered as income, the TFSA can effectively reduce taxes when someone dies, leaving more assets to their beneficiaries.
Withdrawing from a TFSA is easy
With RESPs, withdrawing money can be complicated and have a serious tax implication. Withdrawing from a TFSA is way more flexible: you can withdraw money at any time, for any reason, without paying any tax. And any withdrawals can be added to your total contribution amount in the following year.
What a difference $500 can make
An annual TFSA contribution limit of $6,500 may not seem significant in the short term, but to better understand the real benefit of a TFSA, it pays to look at its impact over a long period of time. Here’s an example:
- A 20-year-old who has never made a TFSA contribution.
- They earn a salary in the top marginal tax bracket.
- They make the maximum contribution to their TFSA of $6,500 every year in a moderate risk portfolio.
- Their estate could increase in value by 5.9%, thanks to tax-free growth.
- Their TFSA lifetime tax savings would be approximately $250,000.
- If they invested instead in a moderately aggressive portfolio, their estate’s value could increase by 10.8%, thanks to tax-free growth.
- Their TFSA lifetime tax savings would be approximately $380,000.
If they were to invest an extra $500 per year, which they will be able to do from 2023, their net estate could increase by $150,000.* So, yes, the TFSA is quite a big deal.
How to get started maximizing your TFSA contribution limit
The huge benefits of the TFSA mean that they should be an essential part of everyone’s financial plan. While the amounts may appear small in the short term, financial planning is not a short-term activity. As we’ve seen, over the long term, TFSAs can have a huge impact on your savings.
Contact your IG advisor to review your plan and discuss ways to make the most of the growing TFSA contribution limit. If you don’t have an IG advisor, you can find one here.
* These figures are based on a 20-year-old with a life expectancy of 90 (so a 70-year investing time horizon). An Ontario resident in the 53.53% tax bracket (the norm when calculating investments up to death).
The TFSA account would grow to:
$1,988,237 in a TFSA versus $1,832,337 in a non-registered account, with a moderate portfolio.
$2,692,811 in a TFSA versus $2,476,161 in a non-registered account, with a moderate aggressive portfolio.
Written and published by IG Wealth Management as a general source of information only. Not intended as a solicitation to buy or sell specific investments, or to provide tax, legal or investment advice. Seek advice on your specific circumstances from an IG Wealth Management Consultant.
