16 TFSA Misconceptions and Myths

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TFSA Misconceptions and Myths.

The Tax-Free Savings Account (TFSA) program was started in 2009 and it has grown in popularity in the relatively short period. I covered the subject in detail in another post about TFSA adoption data. But there are still several TFSA misconceptions, myths and confusions about the program.

Here are some TFSA misconceptions you should be aware of:

#1 Contributions to TFSA are tax-deductible

TFSA contributions, unlike RRSP, are not tax deductible. The contributions are deemed to be after-tax.

That is, your taxable income is not adjusted for the amount contributed and no tax refunds should be expected.

#2 You can only withdraw from your TFSA at retirement

RRSPs are meant to be used for retirement savings. TFSAs, on the other hand, can be used for various goals, both short and long term.

So, there is no restriction on when you can withdraw from your TFSA, or how often. This is simply a TFSA myth.

You could withdraw in a month to buy a car and withdraw the next month for a house’s down-payment.

Ream more: How To Withdraw From TFSA (TFSA Withdrawal Rules)

#3 You can withdraw and re-contribute to your TFSA any time

Related to the above is the misconception that you can withdraw, then recontribute to your TFSA any time during the year. While this is partly true, you need to be mindful of your contribution room.

If you’ve used up your contribution room and then withdraw, you temporarily lose the contribution room and can not recontribute the amount in the same year. You’ll have to wait till January 1st of the next year to put the funds back.

Any excess contributions will be subject to a 1% monthly tax for as long as the over-contribution remains.

To prevent this, make sure you are keeping track of all contributions and withdrawals especially if you have multiple TFSA accounts. You can download a free TFSA contribution tracker here.

#4 Withdrawals from TFSA are taxable

No, TFSA withdrawals are tax free and this is one of the differences between an RRSP and a TFSA. Not only can you withdraw the amounts contributed to the account, any income generated will also be tax free.

#5 You will lose your contribution room if you make withdrawals

Another common TFSA misconception.

Fortunately, this is not the case. Any withdrawals made from the TFSA can be re-contributed but you have to wait till the following year.

For example, imagine 2 friends, Bryan and Michelle. Each contributed $5,000 to their TFSA accounts in 2019. Bryan’s investments suffered some loses but he needed the funds so liquidated the investments and realized $3,500.

On the other hand, Bryan managed to grow her account to $7,500 and also withdrew the funds.

The withdrawals were done in 2020.  Both will be able to recontribute the amounts they withdrew but they’ll have to wait till January 1st, 2021.

Also, though Bryan’s original contribution was $5,000, he can only recontribute the $3,500, a permanent loss in his contribution room equal to the investment loss. Michelle will also be able to re-contribute both her original contribution plus the gains she made for a total of $7,500.

#6 You can’t have more than one TFSA at a time

There is no limit on the number of accounts you can have. Many people open multiple accounts across different banks, robo-advisors, and online brokerages.

However, it is your responsibility, not the financial institutions’, to ensure that you don’t contribute more than your contribution room for the year. The penalties for over-contribution are steep, as discussed above.

Learn more: Can I have Multiple TFSA accounts?

#7 The annual limit is per account

The TFSA limit is per individual, not per account. This is an important point to note. By all means, open as many accounts as you think you need. If you are able to keep track of all the contributions you make, you won’t have a problem with CRA.

#8 You should only contribute to a TFSA after you max out your RRSP

Not necessarily. There are a number of factors to consider, including

  1. Your current tax rate and what you expect it to be in the future: This largely depends on your income level. RRSPs are best if you expect to be in a lower tax bracket than you were when you made the contributions.
  2. Your investment goal: If you are saving for a short or medium-term goal like a new car, a TFSA is better. For a first-time homeowner, you may choose an RRSP and take advantage of the Home Buyers’ Plan.
  3. Investment type: as you’ll see below, certain investments are best held in an RRSP.

#9 TFSA contributions should come before RRSP

Again, this depends on your individual financial circumstances. See response above.

#10 TFSAs are better than RRSPs

The better option between a TFSA and an RRSP will almost always come down to individual peculiarities. As mentioned above, there are several factors to consider

Both saving plans offer tax-sheltering advantages and you should use the two if possible.

#11 You will lose your contribution room if you don’t contribute in a year

This is a TFSA myth. Like an RRSP, unused contribution rooms can be carried forward to a future year.

If you were 18 and a resident of Canada when the TFSA program started in 2009 and you’ve never made any contributions, your accumulated contribution is $88,000 in 2023.

Yes, you’ve missed out on compounded tax-free investment growth, but the good news is your contribution room is still intact.

Check this TFSA guide to learn more about TFSA rules.

#12 TFSAs are like regular bank accounts, just tax-free

Over the years, financial institutions have done a really good job of marketing the TFSA as a regular savings account paying little interest, with the tax shelter as an added feature.

This may be fine depending on your savings goals but in most cases, you are not taking full advantage of the TFSA.

Rather than a normal savings account, the TFSA should be treated like an investment basket, where you can hold different investments like bonds, GICs, Stocks, mutual funds and so on.

#13 You need to have earned income in the previous year to have a TFSA contribution room

On January 1st of each year, every eligible Canadian automatically gets the allowable contribution room for the year. You don’t need to have earned income in the previous year or filed your taxes – like you do for RRSPs.

In addition, any unused contribution room from previous years and withdrawal made in the prior year is added.

Related Post: RRSP Contribution Limit

#14 You can only open a TFSA at a bank

No, you can open a TFSA account with banks, online brokerages, insurance companies, credit unions or any of the robo-advisors.

If you want to manage your investments yourself, many financial institutions will allow you to open a self-directed TFSA.

#15 TFSA withdrawals affect your other income-tested benefits

No, this is a TFSA misconception. Unlike RRSP withdrawals that are added to your income and affect your income-tested benefits like Old Age Security (OAS), Child Care Benefits (CCB), GST etc, TFSA withdrawals do not affect your taxable income.

This makes them an attractive and flexible investment vehicle for many Canadians irrespective of their income level.

#16 You can’t hold foreign securities in a TFSA

You can invest in any foreign securities if it’s traded on a designated stock exchange.

However, you should generally avoid dividend-paying securities. For example, for U.S. assets, taxes are not withheld on RRSP income but Canadians holding U.S. investments in their TFSA are subject to a 15% WHT.

This is because the TFSA is not considered a retirement savings plan, so any foreign income generated may be subject to withholding tax.

Learn more about holding US or foreign stocks in TFSA here.

Final Thoughts on TFSA Misconceptions

Knowing about the common TFSA misconceptions and myths will ensure you don’t make any of the common TFSA mistakes.

To learn more about TFSA and RRSP, check out the posts below:

Related Posts:

Simon is a CPA by day and a Personal Finance Blogger by night. With over a decade experience in financial services, he's passionate about personal finance, investing and helping people take control of their financial life.

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