Ottawa tops up TFSA limit for 2026 but confusion over total limit could trigger costly penalties: Dale Jackson

As of January 1st, adults in Canada can add another $7,000 in contribution space to their tax-free savings accounts (TFSAs).

That’s in line with the $7,000 expansion each year for the past two years, making the total contribution limit for eligible investors who have never contributed to their TFSA since its introduction in 2009 to $109,000.

When things get complicated

Eligible investments held in a TFSA can grow tax-free and be withdrawn any time. The total contribution limit could be much higher than $109,000 for TFSA investors who have made gains and withdrawn funds over the years because the amount withdrawn is restored as contribution space the following calendar year.

Keeping track at any given time can be challenging; especially considering annual allowable amounts have varied through the years to track inflation. Tabulating limits can become mind-boggling for TFSA holders with active accounts through multiple financial institutions or employers.

CRA not responsible for keeping track

Individual TFSA holders are ultimately responsible for keeping track. The Canada Revenue Agency (CRA) normally lists allowable space for individuals on its My Account Portal, but the amount might not be right because it is the responsibility of the financial institution to keep the CRA up to date.

In most cases the correct amount is not updated until later in the calendar year. This year TFSA information was not updated until June or later in some cases.

Over-contributions could result in a penalty of one per cent of the excess amount monthly, which compounds over time.

As the number of TFSA holders grew to nearly 20 million in 2024, the CRA assessed $166 million in TFSA over-contribution penalties; up from nearly $131 million in 2023 and $15 million in 2015, according to data compiled by Canadian finance industry publication Investment Executive.

How a TFSA works

As mentioned, money can be withdrawn from a TFSA at any time and investment returns - be they capital gains on equities, or income from dividends and fixed income - are never taxed.

In comparison, half of capital gains on equities in non-registered accounts are taxed and income is fully taxed. Dividends are also subject to full taxation in non-registered accounts, with the exception of a tax credit on eligible payouts.

It is important to note, however, that non-Canadian dividends in a TFSA are subject to a withholding tax on behalf of the U.S. Internal Revenue Service (IRS). That includes the big U.S. blue-chip companies. It also includes U.S. mutual funds or exchange traded funds (ETFs), and even Canadian mutual funds and ETFs that hold U.S. equities.

From a tax perspective the closest thing to a TFSA available to the average Canadian is the principal residence tax exemption, which allows Canadians to avoid paying any tax on the capital gains they generate from the sale of their principal residences.

As another comparison, (RRSP) contributions - along with the returns they generate over the years - are fully taxed according to the individual’s marginal rate when the funds are withdrawn. TFSA contributions, however, can not be deducted from your current taxable income like (RRSP) contributions.

Like the RRSP, a TFSA can hold just about any type of investments including stocks, bonds, mutual funds, exchange traded funds, real estate investment trusts and even some options.

Using RRSP and TFSA strategically to lower taxes

The TFSA has grown into a powerful retirement investment tool that can be used strategically with an RRSP.

Since RRSP withdrawals are fully taxed, investors can divert contributions to a TFSA well before retirement to avoid higher marginal tax rates and even Old Age Security (OAS) claw-backs, by strategically shifting contributions to their TFSAs well before retirement.

Banking up a significant amount of cash in a TFSA allows retirees to top up needed cash without tax consequences, while keeping RRSP withdrawals at the lowest marginal tax rate.

One important note: Contribution space from TFSA withdrawals can not be reclaimed until the following calendar year. That means if your TFSA is maxed out and you make a withdrawal in the waning days of 2025, you need to wait until 2026 to get it back - along with the $7,000 for everyone else.

https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/tax-free-savings-account/contributions.html