A tax-free savings account (TFSA) gives Canadians the rare opportunity to make capital gains and earn dividends without having to pay taxes on their returns. In 2009, the Canada Revenue Agency (CRA) created a new program that allowed Canadian residents to shelter $6,000 a year in investments in a tax-free savings account.
Although the TFSA contribution limit has changed over the years (in 2023, it’s $6,500), the contribution room accumulates every year just like a Registered Retirement Savings Plan (RRSP). This means any unused room is carried over to subsequent years, allowing you to invest considerable sums of money without having to worry about paying taxes on contributions or earnings. If you were born before 1991, you can deposit a total of $81,500 in 2023 with any future earnings being tax-free.
As the name implies, a TFSA is a savings vehicle that acts as a tax shelter for your earnings. With a TFSA, you won’t have to pay income tax on any interest earned or any capital gains from investments. A TFSA allows you to invest in your savings and to withdraw cash without paying taxes on your earnings and withdrawals. A TFSA differs from an tax-deferred account such as an RRSP, which not only requires you to pay tax on early withdrawals, but to also pay income tax on your withdrawals later in life as if they were an income source. For more, read our TFSA vs RRSP guide.
EQ Bank TFSA
Opening a TFSA is similar to opening a bank account. Canadian residents who are 18 or older and have a valid Social Insurance Number (SIN) are eligible to open a TFSA. To open an account, walk through these steps:
Since a tax-free saving account is a vehicle to shelter your capital gains or the savings interest you’ve earned, how a TFSA works depends on what you’re holding in it. Some choose to hold cash like with a high-interest savings account or HISA, while others choose to hold ETFs, GICs, stocks or bonds in a TFSA—and others hold a mix of investments in a TFSA.
After you open your TFSA account with the financial provider of your choice, make an initial lump sum deposit and contribute annually to watch your savings grow. Just make sure you stick to the general TFSA rules below on TFSA contribution limits and your overall contribution room. You can withdraw from your TFSA at any time, and next year, you’ll have that TFSA contribution limit replenished so you can always add more investments into your TFSA if you haven’t exceeded your maximum TFSA limit.
You can start contributing to your TFSA as soon as you open up an account. This includes depositing cash as well as purchasing investments. Contributions can be made in lump sums or recurring deposits, which you can set up with your TFSA provider.
If you are holding a savings product in your TFSA, such as what you’d find in a high-interest savings account or a GIC , your TFSA will earn interest determined by the interest rate offered by that account. If you hold investments such as stocks, bonds, mutual funds or ETFs, then you won’t earn interest, but you will see capital gains as those investments grow—and you can sell these at any time if you need the funds.
If you contribute more than your total contribution room, you’re subject to a 1% TFSA over contribution penalty. The 1% penalty is applied every month to the excess balance as it remains in the account. Let’s look at an example to understand how the TFSA over contribution penalty works. Annette has a current total contribution limit of $12,000. In 2020, she contributed $6,000. In 2021, she contributed $7,000. Currently, her total TFSA balance is $13,000 which is $1,000 over her $12,000 limit. Unfortunately, Annette didn’t notice the error for 4 months. The CRA charges her $40 ($1,000 x 1% x 4 months) for the error. Annette promptly removed the $1,000 and paid the $40 penalty.
If you incur a TFSA over contribution penalty, you must complete a TFSA over contribution form, also known as the TFSA tax return. If you incurred a penalty as a result of making a contribution to your TFSA when you were a non-resident of Canada, you must complete the TFSA over contribution form as well. The official name for it is Form RC243, Tax-Free Savings Account (TFSA) Return. When you file your annual tax return, be sure to submit this form as well.
There are some general TFSA rules you need to stick to:
For example, the annual TFSA contribution limit from 2009 to 2012 was $5,000. If you didn’t have the spare cash to save in a TFSA, you’ll have $20,000 in TFSA contribution room carried forward from those 4 years.
The lifetime contribution room by 2023 is $88,000. If you’ve already deposited some money over the years, subtract how much you’ve invested so far to figure out your maximum TFSA contribution room.
Keep in mind, contribution limits may change in any given year, so it’s important to check the CRA website to learn more about how much you can put into the fund.
If you want to figure out how to check your TFSA contribution room for the year, take the current year’s annual dollar limit ($6,500 for 2023, for example), any unused contribution room from previous years and any withdrawals made from your TFSA in the previous year. If you’ve made a withdrawal from your TFSA, you can only recontribute this amount in the year after. If you want to find the TFSA limit for the year, check the CRA website to learn more about how much you can put into the fund.
You can also use these resources to determine how much you can put in your TFSA:
Make sure you’re keeping track of your contributions, withdrawals and maximum contribution room to avoid over-contributing. Because CRA updates can be delayed, your TFSA contribution number may not be correct.
You might be wondering how to withdraw from a TFSA. Generally speaking, you can withdraw any amount from your TFSA at any time without penalty. Here are some key TFSA withdrawal rules to bear in mind:
There are TFSA advantages along with some drawbacks you’ll need to take into account.
What types of investments can you make with your TFSA? Like an RRSP, your options are varied and can include the following:
It’s worth noting that TFSA eligible investments include US stocks, too.
If you have cash you’d like to save in a TFSA, you have a handful of investment options to choose from. Choosing the best investments for your TFSA will depend on your individual risk tolerance, your goals and your time horizon. If you’re building up a rainy day fund, you may prefer that cash in a high-interest TFSA that you can quickly withdraw from in case of an emergency. However, if you’re saving for a down payment on a house or for retirement plans in the future, you may opt for buying GICs or bonds that are locked in for a few years at a time.
Some people may be less risk averse with an interest in investing in stocks to try for a bigger return, while others prefer a guaranteed return. Ultimately, it’s your personal preference and your financial situation that you need to take stock of.
Once you’ve decided which route you want to take, work with your financial institution to set up your account and invest your savings.
Don’t forget to stick to the TFSA rules, specifically your TFSA contribution limit for the year and your overall contribution room. The TFSA deadline for making contributions for this year is December 31, 2022. There’s technically no TFSA deadline if you have unused contribution room carried over from previous years though.
While you won’t be charged for depositing or making withdrawals into your TFSA, fees may crop up depending on where you open the account and what kinds of investments you choose. Here’s an overview of some of the fees your financial institution may charge you:
TFSA fees aren’t hidden in the fine print so double-check when you’re choosing which financial institution to work with for your TFSA. As always, do a TFSA fees comparison to help you decide.
As the name suggests, there are no taxes applied to a tax free savings account. When a Canadian contributes to a TFSA, their taxable income is not reduced and there are no tax consequences of withdrawing funds. In addition, interest, dividends and capital gains earned within a TFSA are not taxable.
However, TFSAs have specific contribution rules and there are penalties for a TFSA over-contribution. Every year, the Canadian government specifies a maximum TFSA contribution, and if you exceed that contribution amount you must pay 1% penalty tax on the excess amount for every month the excess remains in the account.
The only other circumstance where you may pay tax on a TFSA is if you become a non-resident of Canada. If you make a contribution to your TFSA when you’re a non-resident of Canada, you’ll be charged a 1% tax on those contributions every month. Generally speaking, a non-resident is someone who resides outside of Canada for the majority of the year (over 183 days).
TFSA holders do not normally have a tax payable. For this reason, the average Canadian does not have to worry about a TFSA tax return.
A person may incur tax on their TFSA if they don’t abide by the contribution rules or make a contribution when they’re a non-resident of Canada. In this case, the account holder must complete and submit Form RC243, Tax-Free Savings Account (TFSA) Return. In other words, Form RC243 is the TFSA tax return, but you only need to use this if you over-contributed or made a contribution as a non-resident.
If you incur TFSA taxes and believe they should be waived or cancelled, you can submit a request to the CRA. They will consider the following factors:
A TFSA isn’t a traditional savings account. Instead, your TFSA account can hold a variety of investments, from ETFs and GICs to stocks and bonds, so there isn’t one catchall TFSA interest rate. With so many ways to invest your money, your TFSA rate of return will fluctuate depending on which option you choose.
ETFs and stocks will fluctuate depending on the market and how their prices change throughout the day. Keep an eye out for fees and commissions you may have to pay for when buying or selling through your brokerage account.
A TFSA is a savings vehicle, which can hold many kinds of investments and savings sheltered from taxes. The main differences between a TFSA vs savings account is that you won’t pay taxes on the interest earned, but you’ll have annual contribution limits to adhere to—and a TFSA can hold other types of investments in it such as GICs, ETFs, stocks or bonds. If you’re not using a TFSA for your savings, and are instead holding all of your money in a traditional high-interest savings account, you’d have to pay taxes each year on the interest earned. To learn more, read our guide on how interest is taxed on savings accounts.
TFSAs are a great opportunity for Canadians to maximize their savings with flexibility. It’s no wonder they’re so popular – your income from your TFSA is 100% tax-free, you can invest in a string of options and you can make withdrawals at any time. Banks, online financial institutions and robo-advisors all offer TFSA products to suit a variety of needs, whether you’re looking for the perfect place to park your emergency savings while earning interest or you’re looking for a big impact return with stocks and ETFs.
You can even spread out your savings across several TFSA accounts each set up for your different financial priorities.
Now that you’re all caught up on TFSAs, it’s time to get in on the tax-free savings. Good luck!
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