The Tax-Free Savings Account (TFSA) is one of the most powerful tools available to Canadians in retirement. But despite its advantages, many retirees are using their TFSAs in ways that reduce long-term value and increase taxes.
Here’s how the TFSA works, and a smarter way to use it in your retirement plan.
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What Is A TFSA?
The TFSA was introduced in 2009 to help Canadians save for retirement or any other goal, tax-free. While it’s called a savings account, it can hold investments like stocks, ETFs, bonds, or mutual funds.
As of 2023, the annual contribution limit is $6,500, and the total contribution room since 2009 is $88,000.
The main benefit is that any growth inside the TFSA, capital gains, interest, or dividends — is tax-free. You get to keep all of it.
When CRA Steps In
Most retirees don’t need to worry, but it’s worth noting: if you use your TFSA for aggressive or frequent day trading, the CRA could consider it a business and tax your gains. This usually doesn’t apply to typical retirement investing.
What Most Retirees Get Wrong
Many retirees have multiple sources of retirement savings, including pensions, RRSPs, TFSAs, and non-registered accounts. When it comes time to withdraw funds, the default is often to tap the TFSA first to “keep taxes low.”
But that strategy can backfire over time.
In most of the retirement plans we build, it makes more sense to use the TFSA later and instead draw from higher-tax accounts like RRSPs or non-registered accounts first.
Why Use Your TFSA Last?
Because registered and non-registered accounts can create a large tax bill at death. Drawing down these accounts earlier, when you’re in a lower tax bracket, can reduce that tax burden.
Let’s walk through a simplified real-life example.
Mr. and Mrs. Smith: two strategies, different results
We worked with a couple we’ll call Mr. and Mrs. Smith. They were both 60 years old, had already started CPP, and converted their RRSPs to RRIFs. OAS would start at 65.
In Strategy 1, they withdrew from their TFSA first to keep their taxes low. Once their TFSA was used up, they turned to their non-registered account and finally their RRIFs. This plan left an after-tax estate of $2.12 million.
In Strategy 2, they did the opposite. They drew from their RRIFs first, then their non-registered accounts, and saved their TFSA for last. This strategy increased their estate value to $2.25 million, a difference of over $125,000.
Why The TFSA Is A Great Long-Term Tool
Since they wouldn’t need to touch their TFSAs for 20 years, Mr. and Mrs. Smith could afford to invest those accounts more aggressively. That doesn’t mean chasing risky stocks, just having a higher allocation to equities compared to other parts of their portfolio.
They were considered balanced investors (a 5 out of 10 on the risk scale). But by investing their TFSA like a 7 out of 10 and adjusting their RRIFs to a more conservative 3 out of 10, their total portfolio risk stayed balanced.
Because their RRIF would be drawn on soon, it made sense to reduce its volatility. Meanwhile, the TFSA had decades to grow tax-free.
The result: more long-term growth, the same overall portfolio risk, and a larger estate, all without taking on more risk than they were comfortable with.
Final Thoughts
If you’re not planning to use your TFSA for many years, you may want to think differently about how and when you access it and how it’s invested.
Used strategically, your TFSA can help you lower your tax bill in retirement and pass more on to the next generation.
For more withdrawal strategies visit our website and book an appointment with us.
