Tax Free Savings Account (TFSA)

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When it comes to saving money on taxes, the Tax Free Savings Account pack a punch.

Not only are all of your capital gains tax-free while held in this account, but they are also not taxable when withdrawn.

Whether you want to save for a vacation, a home, or retirement, the tax free savings account may be a smart option. Learn more about how you can use a tax free savings account to help you grow your money faster. 

What is a Tax-Free Savings Account (TFSA)? 

A tax free savings account, or TFSA, is a registered plan that allows Canadian adults (with a valid SIN) to grow their money tax-free. Despite the word “savings” in its name, a TFSA is more than a savings vehicle. It can hold a variety of investments besides cash, including guaranteed investment certificates (GICs), mutual funds, and stocks.  

TFSAs work similarly to other registered plans, like RRSPs, but have one key difference. You do not pay tax when you withdraw money from your TFSA. 

You can make a TFSA withdrawal at any time and use the money however you like. Some people use TFSAs for short- and mid-term goals, e.g. buying a vehicle, saving for a down payment, or a wedding. Others use it for long-term goals, like retirement planning. 

Key Takeaways

• Any Canadian resident who reaches the age of majority in their province (usually 18 years old) and has a valid SIN can open a TFSA. However, in four provinces and three territories, the legal age is 19. Regardless at what age you open a TFSA, your contribution room begins in the year you turn 18. 
• Tax free savings accounts can help you save money on taxes since the money earned from investing is not taxed. Withdrawals are also tax-free.
• Tax free savings accounts have annual dollar limits, called contribution room. The annual contribution limit for 2024 is $6,500. If you contribute less than the annual limit in a year, the unused amount is carried forward into future years indefinitely.
• The contribution limit is retroactive since 2009, the year TFSAs were established. This means if you turned 18 before 2009, but did not open a TFSA until 2024, you can deposit $88,000 to catch up.  

How does a TFSA work? 

Now that we know what a TFSA is, let's look at the steps to start using a TFSA.

1. Open a TFSA

All adult Canadian residents can open a TFSA. You can open a TFSA using your bank, credit union, or financial institution of your choice. 

Non-residents aged 18 years or older can also open a TFSA, provided they have a valid SIN. However, their contributions will be subject to tax as long as they remain inside the TFSA. 

If you held a TFSA before becoming a non-resident, you may keep it. Any profits earned from money held in a TFSA AFTER becoming a resident are not  taxed. Neither are withdrawals. However, any TFSA contributions made as a non-resident would be taxed at a rate of 1% every month until withdrawn. ‍

2. Contribute to your TFSA

From your bank, insurance company or financial institution. The maximum amount you can deposit in a TFSA in a given year is called contribution room. TFSA contribution limit increases from time to time, depending on the inflation rate. For instance, the annual TFSA dollar limit for 2022 was $6,000, but for 2024 it increased to $6,500. 

Unused contribution room from prior years can be carried forward. For example, if you deposited $5,500 in your TFSA in 2022, you can contribute up to $7,000 in 2024. You can also contribute more than the annual limit, but this is hardly a smart move. Excess TFSA contributions are subject to a 1% monthly tax penalty until withdrawn.

Despite its name, the TFSA can hold various investment income beside cash. Options vary from one provider to the next, but most let you deposit the following assets in your TFSA: 

• Cash
• Bonds
• Stocks
• Mutual funds
• Guaranteed investment certificates

Since tax free savings account contributions are made from after-tax dollars, they are not tax deductible. The good news is that you will not be taxed on capital gains made on investments — even when you withdraw money. 

3. Take money out whenever you want

You can make tax free savings account withdrawals at any time and for any purpose. Here are some other things you should know:

• Money withdrawn from the TFSA is not subject to tax.
• TFSA withdrawals will not reduce any benefits that you receive from the Federal Government, like Old Age Security.
• When you make a withdrawal, your contribution room grows dollar for dollar the following year. Let's say this year you deposited $6,000 so far ($500 less than the annual TFSA limit) and withdrew $2,000. This means you can contribute another $500 to your TFSA in 2024 without facing a tax penalty. However, in 2024 you can deposit up to $8,500 ($6,500 + $2,000 i.e. the amount you withdrew in 2024) — assuming the annual limit does not change.

TFSA vs. RRSP

A registered retirement savings plan (RRSP) is a retirement savings vehicle for Canadians. Like a TFSA, it can hold investment income along with cash. Essentially, both the TFSA and RRSP help you save money, but they do so in different ways. 

Here is a quick rundown of the key differences between the two.

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TFSA Contributions and Withdrawals

When it comes to tax free savings account contributions and withdrawals, keep the following in mind:

Contributions

• A TFSA is subject to annual limits (contribution room). For example, the annual dollar limit for 2024 is $6,500. You can contribute up to this amount without a tax penalty. If you deposit more than $6,500 this year, the excess will be taxed.
• The unused TFSA contribution room rolls over to the next year. So if you only deposit $5,500 this year, you would be able to deposit an extra $1,000 in 2024. 
• The contribution room is retroactive since 2009. Your TFSA contribution limit begins the year you turn 18 and accumulates every year after that — even if you do not have a TFSA. This means if you turned 18 before 2009 but have never contributed to a TFSA, you will have a contribution room of $88,000 in 2024. 
• If you put more money into your TFSA than the annual dollar limit, the extra amount will be taxed at 1% every month until it is withdrawn.

Withdrawals

• You can withdraw money from your TFSA at any time from financial institutions.
• Each TFSA withdrawal increases the maximum contribution room for you. However, the extra contribution room becomes available only from the next year onward.

Tax Deductible Contributions

Tax-deductible contributions refer to certain investments or expenses that can be deducted from your taxable income. This deduction reduces the total amount of income subject to taxation, potentially lowering your overall tax liability. Common examples of tax-deductible contributions include contributions to retirement plans like Registered Retirement Savings Plans (RRSPs) or contributions to Health Savings Accounts (HSAs) in some jurisdictions. By contributing to these accounts, you not only save for your future but also enjoy immediate tax benefits.

TFSA Contributions Room

Your TFSA contribution room consists of the current year’s annual limit plus any unutilized contribution room you accumulated from previous years. Let's say up till 2024 you have accumulated unutilized contribution room of $5,000. Since the annual limit for 2024 is $6,500, you can deposit a total of $11,500 ($6,500 + $5,000) this year from your financial institution. 

How to Open a TFSA? 

Most banks, financial institutions, investment firms, insurance companies, and credit unions offer tax free savings accounts (TFSAs), and many of them let you open an account online with just a few clicks. 

To set up a TFSA, you must: 

• Be a resident of Canada 
• Have attained the age of majority in your province (18 or 19 years)
• Have a valid SIN

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Pros and Cons

Pros

1.Tax-free earnings and withdrawals.

‍Capital gains from investments held in a TFSA are tax-free — as is the money withdrawn from it. 

2.Easy withdrawals.

‍You can withdraw money from your TFSA at any time. When you make a withdrawal, it opens up more contribution room for you.

3.Carry forward unused contribution room.

You can carry over unused TFSA contribution room to future years indefinitely.

4.Doesn’t impact federal government benefits.

‍Capital gains from investments within a TFSA and withdrawals made from it do not impact government benefits.

5.Flexible.

Besides cash, a TFSA can hold a range of savings and investment products.

Cons

1.Contributions are not tax deductible.

‍TFSA contributions do not reduce your taxable income.

2.Contribution room must be tracked.

‍Over-contribution will lead to tax penalties.

3.Does not offer creditor protection.

If you become bankrupt, your TFSA can be seized by your creditors.

Conclusion

The TFSA is a financial tool available to all the residents of Canada who are 18 years or older and have a valid SIN. You can hold various investments in your TFSA, and all of your capital gains grow tax-free. Nor will you have to pay tax when you take out money from your account. 

Frequently Asked Questions

What can you put in a TFSA?

You can put the following types of investments in a TFSA: 

• Cash
• Bonds
• Stocks
• Mutual funds
• Guaranteed investment certificates

Can a TFSA be a joint account? 

No, you cannot hold a TFSA account jointly with your spouse or someone else. Nor can you contribute directly to someone else’s TFSA.  

Can a TFSA have a beneficiary? 

Yes, it can. Your beneficiary receive the money in your account after you pass, and subsequently, your TFSA will be closed. Except for Quebec, all provinces and territories in Canada enable TFSA holders to name a beneficiary. If you live in Quebec and hold a TFSA, you may be able to designate a beneficiary for your account through a will. 

What happens when a TFSA holder dies? 

Apart from a beneficiary, you can also name a successor holder for your TFSA. You can do either one or both. A beneficiary receives the funds in the TFSA after your death, and the account is closed. A successor holder, in contrast, receives your TFSA and the money inside it.

After you pass away, the successor holder can make a tax-free withdrawal and get that tax-free space the following year. For example, if your successor holder withdraws $5,000 from your TFSA, he or she will be able to deposit up to $5,000 from the next year onward. However, a beneficiary does not retain any tax-free room from your account. Only spouses and common-law partners can be designated as successor holders, while siblings, children, and friends can only be listed as beneficiaries.

Coming back to what will happen to your TFSA after you pass, it all depends on whether you have nominated a successor holder or a beneficiary or both. Many TFSAs allow you to list both, but the beneficiary designation comes into effect only after the death of the successor holder. 

Does having a TFSA impact my federal income-tested benefits (e.g. Canada Child Tax Benefit)?

No, it does not. TFSA withdrawals do not reduce any benefits that you receive from the Federal Government.