What Is A TFSA?

The TFSA is a registered tax-advantaged savings and investment plan that was introduced by the Government of Canada in 2009 to incentivize Canadians to save. You can deposit cash into your TFSA and/or use it to hold a variety of investments, like stocks, bonds and GICs. In a TFSA, you generally don’t pay tax on interest, dividends or any kind of capital gains earned from the holdings in your account. This applies both to funds in the account and when you withdraw them.

A TFSA often thought of as a savings account. And while it is one, it’s better utilized as a place to hold different types of assets like stocks, mutual funds, bonds, Guaranteed Income Certificates (GICs) and Exchange-Traded Funds (ETFs). This is because any earnings made on your account holdings—like dividends from your investments or interest from your savings—are tax-free. And you can withdraw anything from the account, included contributions, earnings, dividends and capital gains earned in the account, tax-free as well. Of course, there are exceptions, but this is generally the case.

TFSAs have limits to how much you can contribute. Your “contribution room” is the amount you’re allowed to contribute to your TFSA and it begins accumulating from the time you’re 18 and a resident of Canada— even if you haven’t opened a TFSA or filed taxes. Meaning, if you’ve just opened a TFSA for the first time this year, you’d currently have $95,000 in contribution room (as of 2024), if you were 18 years or older in 2009. However, had you contributed in the past, you’d have eaten away at the contribution room and you would have a lower amount left.

Total cash contribution limit as of 2024 is $95,000, not including any earnings, interest and dividends that have accumulated in the TFSA.

If you haven’t maximized the yearly contribution limits and have withdrawn from the account, those amounts carry over to the following year, beginning January 1.

If you over-contributed, you will have to pay a penalty of 1% per month on the amount you over-contributed (not the whole account value). This is the baseline penalty, but things like the time of the year you contributed and the total excess amount can affect how much you pay in penalties.

For example, say you opened an account in February and immediately contributed the 2023 maximum of $6,500. However, say you then got a $2,000 bonus from your job in October (congrats!) and you decide to put that in your TFSA, too.

Problem is, you’ve now put in $8,500, which is an overcontribution of $2,000. If you don’t withdraw any money, you have to pay penalties. So the math would look like the following:

$2,000 x 1% x 3 months = $60.If you had taken it out as soon as you realized, say in November, you would pay a tax of:

$2,000 x 1% x 1 month = $20.

There are so many benefits to having a TFSA.

• Flexibility. A TFSA is suited toward both short and long-term goals, since your money isn’t locked in, unlike an RRSP, where withdrawals are subject to withholding tax.
• Tax-free growth. Remember that list of assets we mentioned earlier? You can purchase, hold and invest all of them in a TFSA and enjoy tax-free growth. If you open a TFSA early and invest, you could grow your investments over a long period of time.
• Tax-free withdrawals. We talked about this before but you can withdraw from the account tax-free. However, there is one caveat. If you treat your TFSA like a business and do too much trading in it, the Canada Revenue Agency (CRA) can interpret this as a business and you will  be subject to income tax on the earnings. The CRA cracked down on this activity in 2017.
• Retirement planning. Since you can withdraw from a TFSA tax-free, it can be an option for lower-income people who need every dollar they have during their retirement years.
• Saving for a home. Your TFSA can be paired with a First Home Savings Account (FHSA). Homes are ridiculously priced, so using these two accounts in tandem can help you save for a down payment if a home is in your future.

Like everything that sounds too good to be true, there are some downsides to a TFSA.

• Taxable contributions. Contributions to your TFSA do not count as tax deductions, so any money put into an account won’t reduce your taxable income. RRSP contributions, on the other hand, are tax deductible.
• Contribution rules. The contribution rules can be complicated (see the over-contribution rules) but if you’re not sure how much room you have in your TFSA, you can check your tax return or log into your MyCRA account to find the amount.
• Investments. This isn’t unique to the TFSA that investments may not provide good returns but that’s a risk anyone faces when they invest. Also, you can’t day trade in your account. As said before, the CRA does not take kindly to that. Before long, it will start to treat your TFSA  as a business and will tax you on the income you make.

The big difference between a TFSA and an RRSP are the taxes and flexibility. You don’t pay taxes on withdrawals from a TFSA but you do with an RRSP (or when it’s converted to an RRIF).

You also don’t get the tax deduction for TFSA contributions (as you would for an RRSP). Essentially, contributions to your RRSP are deducted from your taxable income that year. For example, if you make $50,000 per year pre-tax and contribute $10,000 to your RRSP, your income for that year will be taxed as if you made $40,000. This could mean a bigger tax refund (or that you owe less money in taxes, if it swings that way).

However, the RRSP is way less flexible than a TFSA because it’s meant as a retirement savings plan. It’s not in your best interest to make withdrawals, since they will be subject to a withholding tax. The one exception is that the RRSP can be used with the Home Buyers’ Plan, wherein you can withdraw $35,000 from your RRSP to use toward the purchase of your first home.

Any Canadian citizen or resident who is at least 18 years old and has a valid social insurance number can open a TFSA account. (You must be the age of majority or an adult in your province to open one.)

If you become a non-resident of Canada, you can keep your TFSA and won’t be taxed in Canada on any earnings in the account or on withdrawals from it. However, if you contribute to it while you are a non-resident, you will be penalized with a 1% tax for each month the contribution stays in your account. Plus, you may have to pay other taxes. Furthermore, contribution room will not build up while you’re a non-resident.

Pretty much anything: Savings, a vacation, a down payment on a house or a car and retirement. Your goals determine your strategy and investments, so plan accordingly.

Bottom Line

The flexibility of the TFSA makes it an appealing tool to have in a financial plan. Partnered with other plans like the RRSP and the FHSA, you’ll have a financial plan that will cover pretty much any big life events.