Tax-Free Savings Accounts (TFSAs) remain your best bet when it comes to retirement investing. With a TFSA, you can permanently protect your capital from taxes.
Not only will your money grow tax free, but withdrawals are also tax free. Because withdrawals can be made at any time for any reason, maxing out your TFSA is an easy decision.
Just be careful, as TFSA rules change every now and then. Ignoring these changes can instantly eliminate many of your biggest benefits.
What to know in 2020
The biggest change each year is usually the annual contribution amount. In 2020, you can contribute up to $6,000 to your TFSA. That’s the same level as last year.
In years prior, however, the limit has changed dramatically. The limit was $5,000 annually from 2009 to 2012, then it was bumped to $5,500 for 2013 and 2014. In 2015, it was temporarily increased to $10,000, only to fall back to $5,500 from 2016 to 2018.
Hopefully these changes won’t be as erratic in the future, as the limit is now dictated by a formula indexed to inflation and rounded to the nearest $500 increment.
Here’s the catch: the annual TFSA contribution limit may not apply to you. That’s because the lifetime TFSA contribution is the number that really matters.
Unused contribution room rolls over from year to year. So if you didn’t max out your contributions in past years, that room is added to this year’s maximum.
For example, if you started a TFSA today and had yet to make a single contribution, you could potentially contribute $69,500, the sum of each year’s contribution maximum since the TFSA was first launched.
So, if your finances allow, make sure to hit the 2020 contribution maximum of $6,000. But if you left contribution room in past years, you may be able to contribute even more.
How do you know what your lifetime maximum is? Contribution room only starts to accumulate in the year you turn 18. That’s because TFSAs are only available to Canadians 18 or older who have a valid social insurance number.
So, if you’ve been eligible for a TFSA since 2009, the year it was first introduced, your lifetime maximum is $69,500. If you turn 18 in 2020, however, your lifetime maximum is just $6,000.
Another important item to note is that withdrawals are still eligible for contribution replenishment. What does that mean?
Let’s say you turn 18 this year and max out your contributions by October, investing $6,000. This November, however, you have some unexpected expenses and are forced to withdraw $500 from your TFSA.
While tapping into a retirement account early is a difficult choice, the penalty-free flexibility of a TFSA makes the withdrawal less painful. Yet there’s another advantage: any withdrawal opens up additional contribution room for the following year.
After hitting the $6,000 contribution maximum for 2020, you can no longer contribute without penalty. Your $500 withdrawal, however, opens up $500 in additional space next year. So if the annual maximum for 2021 is set at $6,500, you’ll actually have $7,000 in contribution space that year.
Of course, filling your TFSA with wealth-generating stocks should be at the top of your to-do list, but paying attention to these small rules can keep your money permanently protected from taxes.
