Siddhi Bagwe
Shannon Terrell
Mary Flory
A tax-free savings account (TFSA) is a registered account you can use to save or invest, without paying taxes on the earned interest or dividends.
Since the federal government introduced TFSAs in 2009, the account quickly became popular with investors. More than half of Canadians (62%) have a tax-free savings account, according to BMO’s 2023 Annual Investment Survey of over 1,500 online participants.
Knowing more about TFSAs can help you decide whether to invest in them and how to maximize their financial benefits.
What is a tax-free savings account?
A tax-free savings account is a government-registered plan that you can use to save a certain amount of money each year without paying taxes on the earnings. A valid Social Insurance Number (SIN) is required to open a TFSA.
A TFSA is similar to other registered plans, such as a registered retirement savings plan (RRSP). The main difference with a TFSA is that although you don’t get a tax break when you contribute, you would not pay any capital gains tax to the Canada Revenue Agency (CRA) when money is withdrawn.
Despite the name, tax-free savings accounts do more than what savings accounts can do.
There are numerous investment options that can be held in a TFSA, including:
All of your earnings and dividends are entirely tax-free when held in a TFSA.
Like standard savings accounts, TFSAs earn interest — though rates are variable and are subject to change. The average rate for a TFSA is 2.75% at the time of this writing, according to NerdWallet analysis of interest rates offered by popular financial institutions.
Some TFSAs have interest rates as high as 5.75%, though these are often offered by digital banks or online divisions of in-person banks and credit unions.
How does a TFSA work?
A TFSA is a unique financial tool that you can use to meet your needs and future goals. Some people use a TFSA for short-term savings, such as an emergency fund or a down payment. Others use a TFSA to build on longer-term goals like retirement savings or investing in the stock market.
TFSAs can be part of a tax-advantaged strategy that allows you to invest in a way that lines up with your goal’s timeline and potential for risk. For example, say, you’re a cautious investor saving up a down payment to buy a house in five years. In a favourable interest-rate market, you may choose a TFSA GIC to grow your tax-free savings till you can withdraw your funds at maturity. The added benefit would be that you get that contribution room back the following year.
However, your investment strategy might be different than if you’re saving for contingency funds or retirement in 30 years.
How to check your TFSA contribution room
TFSAs have annual contribution limits. Before you start investing in a TFSA, make sure you know what your contribution limit is. For 2024, the TFSA contribution limit is $7,000.
If you were eligible to contribute in previous years but didn’t do so, that unused room gets added to the current year’s room. This amount makes up for your overall TFSA contribution room to date. As of 2024, the TFSA total contribution limit is $95,000.
However, if you’ve deposited money in previous years or made withdrawals, you’ll need to factor in those amounts to calculate how much you can deposit into a TFSA.
You can check your CRA My Account for your TFSA room. Although, since financial institutions typically only report your contributions once a year, the contribution room amount displayed in your CRA My Account may not be accurate.
To find out your actual contribution room for the year, you can use the following formula:
Current year contribution limit + unused contribution room from previous years + withdrawals made in previous years = current available TFSA room.
You can also use NerdWallet’s TFSA contribution room calculator to help you find your TFSA contribution room amount to date.
Is there a penalty for TFSA over contribution?
Excess contributions to a TFSA are taxed at 1% of the highest excess amount for each month that the excess amount stays in the account. Additionally, you’ll need to file Form RC243, Tax-Free Savings Account (TFSA) Return and pay any taxes owing by June 30 of the following year.
How TFSA withdrawals affect the contribution room
Any time you withdraw uninvested cash from your TFSA, the amount is added back to your contribution room on January 1 of the following year.
For example, say you had maxed out your TFSA in August 2023 and then withdrew $10,000 in November. On January 2, 2024, you’d be able to contribute $17,000: your $7,000 contribution for 2024 and $10,000 to make up for your withdrawal.
If you withdraw money from your TFSA, you can deposit it again within the same calendar year so long as you have available contribution room.
As for the investments you hold in your TFSA, there may be withdrawal restrictions on some of these investment products, such as term deposits that have a maturity date.
Note that selling investment gains in your TFSA to reinvest the available funds doesn’t count as a withdrawal that restores your contribution room.
Does a TFSA transfer count as a withdrawal?
Transferring your TFSA from one financial institution to another doesn’t count as a withdrawal. To transfer your TFSA, ask your new financial institution to initiate the transfer.
How to open a TFSA
To open a TFSA, you should choose a financial institution, an insurance company or an investment firm that best suits your needs.
To apply for a TFSA you’ll need to:
- Be a Canadian resident (non-residents pay 1% tax for each month the contribution stays in your TFSA).
- Have a valid SIN.
- Be at least 18 or the age of majority in your province.
You’d be able to open a TFSA and contribute the full amount of the contribution limit for the year on the day you attain majority. Let’s say you’re turning 18 on November 1, 2024. You’d be able to open a TFSA and contribute the full amount for the year ($7,000) on that date.
When you’re considering your TFSA investment options, you may choose to invest in a regular deposit account with a financial institution or a self-directed TFSA with a brokerage.
While a bank may offer limited options to hold GICs, high-interest savings accounts (HISAs) and mutual funds in your TFSA — a self-directed TFSA brokerage account can provide additional alternatives, such as stocks, exchange-traded funds (ETFs), bonds, and more. Additionally, a self-directed TFSA allows you to be in total control of the investments you choose.
Is a TFSA worth it?
A tax-free savings account can be a good choice for those seeking registered options to maximize their tax-free earnings. Some features that make TFSAs a great addition to your investment strategy include:
- Tax-free earnings. When it’s time to make a withdrawal, you don’t have to pay the CRA for what you’ve earned.
- Easy withdrawals. A tax-free savings account can be a convenient way to save and access cash for emergencies without paying tax. Plus, account holders who make withdrawals get the contribution room back in the following year.
- New contribution limit each year. Regardless of your income, everyone gets an increased TFSA contribution room annually that they can use for future planning.
- Versatility. You may appreciate having the different savings and investment options that a TFSA allows for short and long-term goals, including bonds, stocks and ETFs.
Even though a TFSA can be a right fit for many people, there are a few reasons why it may not be a good candidate for your investment portfolio, including:
- No immediate tax break. If you’re looking for an upfront tax break, consider making contributions to an RRSP instead.
- Complicated rules. Investors who find the TFSA rules difficult to follow may not be able to use the account to its maximum potential and may be better off using a non-registered plan.
- Contribution room must be tracked. Having multiple investments at various financial institutions may result in penalties due to excess contribution. That’s mainly because CRA does not record contributions in real-time.
- Day trading isn’t allowed. The CRA considers day trading to be business income, and it’s not allowed in your TFSA.
TFSA alternatives to consider
RRSPs and TFSAs are government-registered accounts designed to help you save and invest. They both offer tax benefits — but the nuance of how these benefits work is what differentiates RRSPs and TFSAs. Whereas, a savings account generally holds cash and earns interest without tax advantages. Knowing what sets these accounts apart can help you determine how to best utilize each one.
TFSAs vs RRSPs vs savings accounts
| TFSAs | RRSPs | SAVINGS ACCOUNTS | |
|---|---|---|---|
| Eligibility | Canadians at least 18 years of age with a valid Social Insurance Number (SIN). | Anyone who earns income and pays taxes. | Anyone with a valid Social Insurance Number (SIN). |
| Contribution limit | $7,000 for 2024. | 18% of your income, up to $30,780 for 2023 and $31,560 for 2024. | No maximum deposit limits but minimum balance requirements may apply. |
| Contributions tax-deductible? | No. | Yes. | No. |
| Tax-free withdrawals? | Yes. | No. | No. |
You may choose a savings account, RRSP or TFSA as the best place to stash your cash but you don’t need to select one over the other — you can have them all.
Frequently asked questions about TFSAs
Yes. The Canada Revenue Agency automatically receives an annual TFSA record on your behalf from the bank or credit union that issues your tax-free savings account.
No. You typically don’t need to claim anything TFSA-related on your tax return unless you over-contributed or became a non-resident of Canada.
You’re allowed to have more than one TFSA, but your total contribution room doesn’t change. It’s shared between all of your accounts. Understanding the rules is vital, as you’ll be able to use your TFSA to your advantage while avoiding any penalties.
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