The Tax-Free Savings Account (TFSA): What You Need to Know

The Tax-Free Savings Account (TFSA) is a registered account created in 2009 in Canada.

The aim is to save and invest tax-free to finance short-, medium- and long-term projects. It’s one of the most versatile savings plans available, with annual contribution limits, no limits or taxes on withdrawals, contribution catch-up, eligible investments and more.

For the more frugal among us, it’s even possible to plan a tax-free retirement from a TFSA, while benefiting from social programs such as the Guaranteed Income Supplement (GIS).

If you want to improve your financial situation and learn new financial skills, this TFSA guide is for you. Who knows, this information may help you make better decisions and achieve your financial goals.

The Tax-Free Savings Account (TFSA) is a registered savings account that allows Canadians aged 18 and over to contribute money, invest in the account and make withdrawals tax-free.

This savings plan was introduced by the federal government in 2009. The annual limit was $5,000, and its original purpose was to help Canadians reach their savings goals. In the years that followed, and with the increase in contribution rates, a number of tax strategies emerged. The cumulative ceiling is currently $88,000, and will be increased to $95,000 as of January 1, 2024 .

The TFSA is not an investment or a financial product. It’s more like a savings account in which you can invest. While many Canadians limit themselves to savings products (hence the name “tax-free savings account”), the TFSA is not limited to these types of investments. In fact, you can invest your TFSA deposits in the stock market, including equities and ETFs, by using an online broker like Questrade.

Investment income, such as capital gains, dividends and interest income, are not taxable.

The eligibility criteria for a Tax-Free Savings Account (TFSA) are as follows:

• You are 18 years old or over
• You are a resident of Canada
• You have a valid Social Insurance Number (SIN)

You can open more than one TFSA account. For example, a TFSA with a financial advisor at your financial institution and a TFSA with an online broker (to invest in the stock market yourself). However, all TFSA accounts must respect contribution limits and room.

The amount you can deposit into your Tax-Free Savings Account (TFSA) each year depends on your contribution room. These correspond to the current year’s contribution rights, unused rights from previous years and withdrawals from the previous year.

TFSA investment income (capital gains, dividends and interest income) does not reduce your contribution room for the current or subsequent years.

Unlike the FHSA, TFSA contribution room has been accumulating every year since 2009 (or from the year you turn 18), even if you haven’t opened a TFSA. However, unlike RRSPs, TFSA contributions are not tax-deductible.

Here is the TFSA contribution room and lifetime limit since its introduction in 2009:

*Cumulative ceiling for a Canadian resident aged 18 or over in 2009

If you didn’t notice from the table below, the TFSA contribution limit in 2024 is $7,000. As a result, you may have a lifetime TFSA contribution limit of $95,000 if you have never contributed to a TFSA and have met the eligibility criteria during that period.

Excessive contributions can result in substantial financial penalties. The excess amount in your TFSA will be subject to tax (1% per month). For example, if you have made $5,000 in excess contributions to your TFSA, you must pay $50 each month for as long as the excess amount remains in your account.

You can make tax-free withdrawals from your Tax-Free Savings Account (TFSA) at any time of the year. A qualifying transfer from one TFSA to another is not considered a withdrawal.

However, it is important to understand that withdrawals from your TFSA do not reduce the total amount of contributions you have already made for the year. In other words, TFSA contribution room does not change during the year, despite a withdrawal. However, these withdrawals will be added to your TFSA contribution room at the beginning of the following year.

Let’s take an example. Let’s assume your TFSA contribution room for a given year is $6,500. At the beginning of the year, you decide to contribute $5,000. As a result, your TFSA contribution room for the current year is reduced to $1,500 ($6,500 – $5,000 = $1,500). Later in the year, you have an emergency and decide to withdraw $4,000 from your TFSA. At that point, your contribution room for the current year remains unchanged (i.e. it is not increased by $4,000). Your contribution room for the current year remains at $1,500. Only the following year will this $4,000 be added to your contribution room, in addition to your new room for the new year.

Transfers between your own TFSAs and transfers from one issuer to another by a financial institution are considered qualifying transfers. The latter have no tax consequences.

However, if you withdraw funds from one TFSA and deposit them in another TFSA, this transaction is not considered a qualifying transfer. It’s more like a withdrawal, followed by a new contribution. If you don’t have enough contribution room for the current year, you will have made an over-contribution and will have to pay a penalty (see section “Penalty for over-contribution”).

The process for opening a Tax-Free Savings Account (TFSA) in Canada is very simple. Canadian residents 18 years of age or older can visit their bank, credit union, insurance company or trust company to open a TFSA.

You can also open a TFSA account with an online broker (discount broker), if you wish to manage your own investment portfolio.

Note that it is possible to open multiple TFSA accounts, as long as contribution limits and room are respected.

There are several ways to invest in your TFSA account. However, the investments you choose must match your financial goals and risk tolerance. Depending on your knowledge and level of financial literacy, you can either use a self-directed TFSA or work with an investment advisor.

A self-directed TFSA is advantageous for the informed and confident investor. You minimize the fees incurred on your account, you have much more control and you can see incredible gains over the lifetime of your investment. In short, you are not limited in your investements, and the growth of your account is truly unlimited.

To invest your TFSA in self-directed investments, you need to open an account with a brokerage platform. Examples of brokerage platforms are: Desjardins Online Brokerage (Disnat), National Bank Direct Brokerage, Questrade and Wealthsimple Trade.

Challenges: With great power comes great responsibility. Self-directed TFSAs risk losses. You are entirely responsible for managing your portfolio. That’s not to say you shouldn’t do it, but it’s essential to know the risks before you take the plunge.

If your level of financial knowledge is weak, or you’re simply not interested in managing your own investments, you can have an advisor manage the investments in your TFSA account for you.

You can do this through a financial advisor at your bank, credit union, insurance company, or trust company. In fact, don’t hesitate to contact your advisor or make an appointment with them if you need information or have any questions.

Other options include using a robo-advisor such as Wealthsimple Managed Investments or Questwealth Portfolios.

If you’re investing for the long term, this can be an advantageous strategy while working on other financial goals.

Challenges: There are fees associated with having your accounts and investments managed by professionals. In Canada, average management expense ratios (MERs) range from 2.23% to 2.53%. These fees reduce the net return on your TFSA. For example, if your TFSA account, managed by a financial advisor, generates a 5% return, but management fees are 2.3%, then the net return on your portfolio is 2.7%.

While many Canadians use their TFSA as a savings account or emergency fund, there is a wide choice of eligible investments. Since TFSA earnings are tax-free, it’s generally more advantageous to invest in investments that have the potential to generate higher returns. Provided its investments match your investor profile.

Here is a non-exhaustive list of the types of investments eligible for the TFSA:

• Cash
• Guaranteed Investment Certificates (GICs)
• Money Market funds
• Mutual Funds
• Government or Corporate obligations
• Company shares
• Exchange Traded Funds (ETFs)
• Asset allocation ETFs
• Call and put options

In most cases, investments made within a TFSA are not subject to tax, either when the funds are held in the TFSA or when they are withdrawn. The same applies to investment income within the TFSA, such as capital gains, dividends and interest income.

However, there are cases where a TFSA holder may incur taxes. First of all, there’s the tax on excess contributions, which has already been discussed in this guide (see section “Penalty for excess contributions”).

Then there’s the tax to pay on non-resident contributions. For example, if you have made contributions as a non-resident of Canada, you will be subject to a tax of 1% per month on these contributions.

To find out more about taxes payable on Tax-Free Savings Accounts (TFSAs), make an appointment with your financial advisor or visit the Canada Revenue Agency (CRA) website.

As uncomfortable as it may be, in the event of an untimely death, there are a few things to keep in mind when it comes to your TFSA account. Tax implications may vary depending on the following factors:

• Type of TFSA (deposit, annuity contract, or trust arrangement)
• Type of beneficiary (survivors, designated beneficiaries)
• Income generated after death
• Duration of payments to beneficiaries after the death of the TFSA holder

If a TFSA holder dies and leaves a beneficiary, the TFSA will go directly to the beneficiaries. They may be common-law partners, spouses, children or family members.

To find out more about the taxation of TFSAs on death, make an appointment with your financial advisor or visit the Canada Revenue Agency (CRA) website.

The TFSA can only be opened by one person. There is no such thing as a “spousal TFSA”, unlike a “spousal RRSP”.

However, there are several strategies you can use to allow your spouse or common-law partner to benefit from all or part of your TFSA. For example, give money to your spouse or common-law partner and name him or her as the beneficiary of your TFSA.

Note: A common-law partner is a person who is not your spouse, who has a conjugal relationship with you, and who meets at least one of the following conditions:

• This person has been living with you in a conjugal relationship for at least 12 months.
• This person is the parent of your child (birth or adoption)
• This person has custody or responsibility of your child

You can give money to your spouse or common-law partner to contribute to his or her own TFSA. Of course, contributions made by your spouse or common-law partner to his or her TFSA must not exceed his or her contribution room. In addition, the contributions and income generated in your spouse’s or common-law partner’s TFSA belong to him or her.

You can name your spouse or common-law partner as the designated beneficiary of your TFSA. One advantage is that the designated beneficiary will not pay tax on total payments from the TFSA that do not exceed the fair market value of all assets held in the TFSA at the time of the holder’s death. In addition, designated beneficiaries can contribute an amount to their own TFSA if they have unused contribution room. Note that in Quebec, you can only name a designated beneficiary on an annuity or insurance contract.

If you meet the eligibility criteria, you can open a Tax-Free Savings Account (TFSA) at most financial institutions in Canada. Specifically, banks, credit unions, insurance companies and trust companies can issue TFSAs.

If you’d like to manage your own investment portfolio, you can open a TFSA account with an online broker (discount broker) like Questrade.

As explained in this guide, the TFSA is one of Canada’s most versatile registered savings plans. In particular, due to :

• TFSA contribution limit increases over the years (e.g. $6,000 in 2022, $6,500 in 2023 and $7,000 in 2024);
• No limits on withdrawals and no taxation on withdrawals;
• There is no limit to the amount of contributions that can be made up;
• Wide choice of eligible investments.
  

For more information on the Tax-Free Savings Account (TFSA), you can make an appointment with your financial advisor or visit the Canada Revenue Agency (CRA) website.

Here are answers to the most frequently asked questions about the Tax-Free Savings Account (TFSA).