What Is A TFSA (Tax-Free Savings Account)?

Do you know what is a TFSA? It stands for Tax-Free Savings Account. This account was introduced in 2009 and has quickly become one of the most popular accounts available to Canadian residents. 

The account is so flexible that it can be used for just about anything, including retirement or short-term savings. Alternatively, some people use the account to hold their emergency funds. 

Even though the account is ideal for different situations, you can’t just use it freely. There are specific contribution and withdrawal rules to be aware of. In addition, there are tax benefits and potential tax consequences when using the account.

What is a TFSA?

A TFSA is a registered account that comes with tax benefits. Whenever you contribute to your TFSA, there is no tax break. However, your account’s interest and capital gains are completely tax-free. Even when you withdraw the money that you made, there are no taxes to be paid.

For example, let’s say you’ve contributed $50,000 to your TFSA over the last 10 years and your portfolio now has a value of $70,000 since you invested your money. You’ve now decided to withdraw the entire amount as a down payment for a home purchase. When you withdraw the money, there are no taxes to be paid. You don’t even need to report or disclose any information when you make the withdrawal.

What investment products can be purchased in a TFSA?

When researching what is a TFSA, the first thing you need to understand is that it’s not just a savings account. Many people don’t realize they can purchase different investment products inside their TFSA. Think of your TFSA as an investment vehicle that includes the following:

• Cash – If you plan on using your TFSA as your emergency, holding cash within a TFSA high-interest savings account (HISA) will allow you to grow your funds slightly.
• Guaranteed Investment Certificates (GICs) – If you have a short-term investment timeline but still want to earn interest, GICs can be attractive since their terms are typically one to five years.
• Government and corporate bonds – Another type of fixed income investment is government and corporate bonds.
• Individual stocks – For those looking to use their TFSA for growth, equities such as individual stocks can help you reach your long-term goals.
• Mutual funds – Instead of picking individual stocks, mutual funds can give you access to a diverse portfolio within a single fund.
• Exchange-traded funds (ETFs) – ETFs are also a pooled investment option, but they have a lower management expense ratio than mutual funds since there is no portfolio manager. 

While many investment products can be held within your TFSA, a few exceptions exist. Cryptocurrency and Non-Fungible Tokens (NFTs) can’t be purchased within your TFSA unless you’re purchasing a qualifying ETF that has exposure to them.  

Who is eligible for a TFSA

To qualify for a TFSA, you must meet the following requirements:

• You must be a Canadian resident
• You must have a valid Social Insurance Number (SIN)
• You must be the age of majority in the province or territory you reside in

Note that the age rule applies to your actual birthday, not the calendar year. So, if you were born on December 30, you wouldn’t be able to open a TFSA until you turn the age of majority in the province or territory you live in. 

Eligibility for non-residents of Canada

You can still keep your TFSA if you ever become a non-resident of Canada, but there are a few things to be aware of. First off, your gains and withdrawals won’t be taxed from Canada. However, not every country recognizes the tax benefits of your TFSA. For example, if you move to the U.S., the withdrawal gains from your TFSA would count as income and would need to be reported.

In addition, if you’re a non-resident, you wouldn’t be able to make contributions without paying a 1% tax for each month the contribution remains in the account. Plus, you may be liable for other taxes while you reside in another country. Many non-residents of Canada will typically close their TFSAs before leaving, so they don’t have to deal with the tax consequences.

How to open a TFSA

Opening a TFSA is easy since you can open one at most financial institutions, including credit unions and digital banks. In addition, some insurance companies can also open a TFSA for you.

To open a TFSA, you can do one of the following:

• Go to a branch – Anyone new to investing will likely want to go to the local branch at their financial institution to set up their TFSA.
• Call your financial institution – Many financial institutions allow you to open up a TFSA over the phone. 
• Go online – You can often set up your accounts online. If you’re opening up a TFSA with a digital bank or robo advisor, online is the only way to go.

If you plan to open an account online or call in, you’ll likely need to provide additional documentation to verify your identity. That said, if you’re already a client of the financial institution, you may be able to bypass that step.

Keep in mind that opening a TFSA is just one step. You’d still have to fund your account and then purchase investments. A financial advisor can recommend some investment products if you’re opening an account with your financial institution. 

If you prefer to manage your investments yourself, you can open up an account with a discount brokerage such as Questrade or TD Direct Investing. This would give you full control over your portfolio.

When opening a TFSA, you would set your beneficiary. This can be anyone, including your spouse, common-law partner, children or someone else. Having a beneficiary in place is a good idea since it won’t leave your account in limbo if you were to suddenly pass.

What is the TFSA limit?

When researching what is a TFSA, one natural question to ask is, what is my TFSA limit?  Your contribution room depends on what year you turned the age of majority in the province in which you live. 

Here’s how much TFSA contribution room was allocated each year since TFSAs were introduced:

• 2009: $5,000
• 2010: $5,000
• 2011: $5,000
• 2012: $5,000
• 2013: $5,500
• 2014: $5,500
• 2015: $10,000
• 2016: $5,500
• 2017: $5,500
• 2018: $5,500
• 2019: $6,000
• 2020: $6,000
• 2021: $6,000
• 2022: $6,000
• 2023: $6,500

Assuming you became eligible to open an account in 2009, your current TFSA contribution limit would be $88,000. However, if you became eligible in 2020, your maximum contribution limit would be $24,500.

Towards the end of the year, the government announces what the annual contribution limit will be for the next calendar year. They base that number on inflation.

TFSA contribution limit carry forward

Your TFSA contribution limit carry forward is quite generous since unused contribution room carries forward indefinitely. That means any unused room can be used at a later date. In addition, any withdrawals you make can be contributed later (a further explanation is found below)

TFSA over contribution

A TFSA over contribution is when you contribute more money than you have in available space. When this happens, you’ll be required to pay a tax penalty of 1% each month for the excess amount. Since your financial institution and the government of Canada won’t warn you if you go over your limit, you need to track your contributions on your own. 

Where can I find my TFSA contribution room limit?

The quickest way to find your TFSA contribution room information is to check your My Account for Individuals via the Canada Revenue Agency (CRA) website. Once logged in, you can see your TFSA contribution room limit under RRSP and TFSA.

While this method is the quickest way to see how much room you have, it’s not updated in real time. Financial institutions typically only report contributions once or twice a year. That means the number you’re seeing may not be accurate. If you want to know for sure how much contribution room you have left, you should be tracking everything on your own in a spreadsheet.

TFSA deadline

There is no TFSA deadline. You can contribute to your account whenever you want as long as you have available contribution space. You can also withdraw funds from your TFSA whenever you want. In addition, you can keep your TFSA open indefinitely. There’s no need to convert it to another account when you retire. 

TFSA rules for withdrawal 

Without a doubt, the TFSA rules for withdrawal are what confuses people the most. You can withdraw funds from your TFSA whenever you want. However, it’s the re-contributions that throw people off. Basically, you can only re-contribute to your TFSA if you have available contribution room.

For example, let’s say your TFSA is currently maxed out. On July 1, you decided to withdraw $10,000 to do some kitchen renovations. You would only be able to re-contribute that amount the following year. That means on January 1, you could contribute $10,000, plus the new limit for the year. 

Your TFSA is not like a high-interest savings account. The contribution rules will still apply even if you’ve withdrawn funds from your TFSA. 

Now let’s say your TFSA wasn’t maxed out. Instead, you have $50,000 in contribution space. If you took out $10,000, you could re-contribute that amount in the same calendar year since you still have the room available. You would get the $10,00 in space back the following calendar year. 

Remember, financial institutions only share your contributions to the CRA once or twice a year, so you’ll want to keep track of things yourself if you plan on making multiple withdrawals from your TFSA. 

The benefits of investing in a TFSA

Even though you might know what is a TFSA by now, you’re likely still wondering if it makes sense for you. Generally speaking, everyone should have a TFSA since it provides the following benefits:

• No taxes paid – All interest and capital gains earned are entirely tax-free. Compare that to capital gains in a non-registered account where 50% of your profits are taxable.
• Contribution room is the same – Unlike Registered Retirement Savings Plans  (RRSPs) contribution room that’s earned based on your income, the TFSA contribution room is the same for everyone who qualifies.
• Flexibility – Your TFSA is not just a savings account. You can purchase different products within it that can help you meet your investing goals.
• Additional registered account – If you can afford to max out your RRSP and TFSA, you can quickly build tax-deferred and tax-free income.
• Does not affect benefits – Since income from your TFSA doesn’t get taxed, it doesn’t affect benefits such as Old Age Security (OAS) and Guaranteed Income Supplement (GIS)

TFSA alternatives

While the tax advantages of a TFSA are pretty clear, there are a few other accounts worth considering. Which account/s you choose should be based on your goals and individual circumstances.

Registered Retirement Savings Plan

With your RRSP, you get a tax deduction when you make a contribution, and any interest, dividends, and investment income made within the account are tax-free. However, when you eventually withdraw the funds from your RRSP, it’ll count as regular income, and you’ll pay taxes at your marginal tax rate. Generally speaking, RRSPs are better for people who make $50,000 or more since the tax break you get from contributions is worthwhile.

High-Interest Savings Account

In an ideal world, you’ll use your TFSA for long-term investing where you can capitalize on the tax-free gains. If your account is indeed maxed out, then using a HISA for short-term goals such as saving for a home down payment is ideal. 

How to transfer TFSA

If you already have a TFSA but have just learned that you can do more with it, you still have options. Transferring your RRSP to another financial institution is easy. All you need to do is have your new financial institution request a transfer of funds from your current account. By doing this, you won’t need to make any withdrawals.

Alternatively, you could withdraw all of your funds one year, and then re-contribute them the following year to your new account. You could then close your old account.