Andrew Goldman has been writing for over 20 years and investing for the past 10 years. He currently writes about personal finance and investing for Wealthsimple. Andrew's past work has been published in The New York Times Magazine, Bloomberg Businessweek, New York Magazine and Wired. Television appearances include NBC's Today show as well as Fox News. Andrew holds a Bachelor of Arts (English) from the University of Texas. He and his wife Robin live in Westport, Connecticut with their two boys and a Bedlington terrier. In his spare time, he hosts “The Originals" podcast.
A Tax Free Savings Account (TFSA) is not only one of the great wonders of the world, it’s also one of the great misnomers of the English language. Why is that? Well, it’s not a savings account at all.
We don’t know who decided to call it a savings account, but whoever it was should probably relinquish the part of his or her job that involves naming stuff! We’re about to give you a whirlwind primer on all things TFSA. Should you hope to go a little deeper on the big topics we cover, don’t hesitate to check out more in-depth articles on the following topics:
What is a TFSA?
Though TFSA is an acronym for Tax Free Savings Account, it’s not really much at all like those savings accounts you probably had as a kid--ones that earned almost no interest but provided access to all-you-can-eat stale lollipops from your local bank branch. Instead, think of a tax-free savings account (TFSA) as a basket. You can pick what to put in that basket from a bevy of financial instruments—exchange traded funds, guaranteed investment certificates, stocks, bonds and yes, actual savings accounts. The Canadian government introduced TFSAs in 2009 as a way to encourage people to save money. Since you paid tax on the money you put into your TFSA, you won’t have to pay anything when you take money out.
How Does A TFSA Work?
How a TFSA works is very simple. You open a TFSA, deposit money and hopefully watch your money grow. One of the greatest features of the TFSA is their flexibility in terms of when you can withdraw your money. Unlike an RRSP, you’re free to withdraw at any time without penalty, but there are government-mandated limits to how much you can contribute every year. The maximum you’re allowed to put into a TFSA each year is known as the contribution limit and it varies from year to year. It’s a good idea to take a gander at this year’s limit and past limits before you open a TFSA and start contributing. That’s because over contributing comes with a nasty little penalty — 1% of the excess contribution every month until it’s withdrawn.
If and when you do withdraw money from a TFSA, the amount you take out is added to how much you can contribute the following year. For example, withdrawing 5,500—plus $5,000. And TFSA contribution room doesn’t disappear if you fail to contribute in any given year. It just rolls over into the next year so you’ll have an ever-expanding contribution limit.
Advantages of a TFSA
A TFSA is what’s often referred to as a “tax-advantaged account,” meaning the government provides tax breaks for those who them as an incentive for saving for retirement or some other large purchase like a home. TFSAs are considered tax-exempt. While contributions to a TFSA earn you no immediate tax breaks like RRSP contributions would, you will however receive big breaks in the future, since all investment gains will not be subject to any taxes. In other words, since you already paid tax on the money you put into your TFSA, you won’t have to pay anything when you take money out.
Limitations of a TFSA
TFSA's are pretty great, but they can also get you into a bit of trouble if you're not careful. Because TFSAs are so popular and plentiful and you can open as many as you want, it’s easy to lose track of how much you’re contributing. As we outlined above, even if it's by accident, should you accidentally over-contribute (i.e., put in more money in a calendar year than you’re allowed by law), you will be charged a penalty of 1% per month on the amount in your TFSA that is in excess of the limit. Oh, and remember that you can’t day-trade stocks in your TFSA, unless you’d like to experience the wrath of the Canadian government’s tax department.
TFSA contribution limits
When setting TFSA limits, the government doesn’t plan too far ahead.
The lifetime limit for 2019 is $63,500. If you’ve deposited some money over the years, just subtract that number from your total lifetime limit to arrive at your maximum contribution. If you've made any withdrawals from your TFSA you can recontribute them the year after you made the withdrawal. As soon as the CRA sets a new limit, they’ll update their contribution limits page.
TFSA investment options
As we’ve explained, TFSAs are just baskets in which you might put any kind of investment, so you might choose to invest in stocks, bonds, real estate, or smelly but adorable alpacas. A number of factors will dictate how you invest, including your risk tolerance and investment horizon, aka, when you need to access the money. Two articles will be of particular interest to you. TFSA Investment Options and Strategy will offer some specific tips on TFSAs, while How To Buy Stocks, Beginners Guide will provide invaluable step-by-step advice on stock market investments, which will likely be a big part of where your TFSA dollars go.
TFSA rules (withdrawals and over contributions)
Pretty much any rule query you could imagine will be answered on the TFSA Rules You Need To Know page, but here are two basic things to remember:
Don’t over-contribute; if you do you’ll be assessed a 1% penalty on the excess contribution every month until it’s withdrawn.
Understand TFSA contribution rules; if you hope to replace money you withdraw from your TFSA, you’ll have to wait until the year following your withdrawal to earn that contribution room back.
TFSA vs. RRSP
Since both TFSAs and RRSPs are phenomenal in their own ways and somewhat similar in how they operate TFSA vs. RRSP is a kind of a Batman vs. Superman question, one you might weigh carefully after reading about the relative merits and drawbacks of the two.
Michael Craig, Portfolio Manager at Wealthsimple points out—if you're already benefiting from the tax advantages that come with an RRSP then you should also take advantage of a TFSA.
"If you're already contributing to an RRSP each year and receiving a healthy tax refund you may want to consider contributing to a TFSA too."
In addition here are are a few of the biggest factors to consider when it comes to choosing between a TFSA and an RRSP:
If you haven’t contributed much towards your retirement and you happen to have access to a pile of money right now through, say, a bonus, or inheritance, a TFSA might be the best option for you, since RRSPs have what's called an annual deduction limit, meaning that you won't be able to deduct over a certain amount in any given year. The number for 2020 is $27,230 but you can find past, current and future deduction limits on this CRA page.
TFSAs are designed to be easily accessed before retirement—which is good, especially for those with a more immediate goal in mind like buying a house or car. Because their funds are so darned easy to access, TFSAs are less good if you happen to be the type who’s never been able to resist smashing a piggy bank.
If the funds you're investing are for your retirement, TFSAs are generally considered preferable to RRSPs for those earning less than $50,000 a year, for tax reasons more fully spelled out in this article on TFSAs vs RRSPs.
While withdrawal and contribution rules are usually the most-discussed aspects of TFSAs, you’ll probably want to avoid any nasty surprises come tax season, right? Because although it’s technically a “tax-free” account (it’s in the name!), there are still some instances where you’ll be taxed on the account.
Generally, interest, dividends, or capital gains earned on investments in a TFSA are not taxable, both when they’re in the account or when they’re withdrawn. But if you exceed your contribution room for the year, then you’ll have to pay tax on the excess TFSA amount. If you end up going over your contribution room, then you’ll have to pay a 1% tax on your highest excess TFSA amount in that month. For more information, see example 4 on this page. So, for example, if you have an excess of $500 in September 2019 and don’t take any measures to correct that excess for the rest of the year, you’ll be paying $5 per month for four months until the year is over.
Another time you’ll have to pay taxes on your TFSA? When you qualify as a non-resident of Canada. If you make any contributions to a TFSA during a year where you’re a non-resident of Canada, you’ll be charged a 1% monthly tax on those contributions. As a reminder, you’re considered a non-resident if you live outside of Canada for the majority of the tax year. You can find more information on TFSA taxes for non-residents here.
How to open a TFSA
Any Canadian who is 18 years of age or older with a valid social insurance number (SIN) can open a TFSA. All you need to is reach out to a financial institution, credit union or insurance company who offers TFSAs and provide your SIN and date of birth. It’s likely they’ll ask you for supporting documents like a birth certificate to prove you are you who you say you are. Unless you're trying to impersonate someone else, the process shouldn’t take any more than ten minutes to complete. You obviously have many choices of institutions where you might open a TFSA, but consider trying to find one that requires no minimum investment, charges low fees, and provides unlimited phone support from knowledgeable humans for every client. Ready to take five minutes to open the finest TFSA imaginable? Sign up to Wealthsimple, the only automated investing services to offer all of its client’s unlimited human support. Every Wealthsimple client gets state of the art technology, low fees and the kind of personalized, friendly service you might have not thought imaginable from a low-priced investment service.
Moving a TFSA from another bank or financial institution
The good news for those searching to switch banks is that it’s blessedly simple: There may be a fee to transfer a your TFSA but it might get reimbursed by your new financial institution. It’s best to check in with both to make sure you know the charges. There are generally no tax consequences of moving a TFSA—they don’t call it a tax free savings account for nothing! But do keep in mind that when you authorize the transfer, you’ll usually be asked whether you'd like to transfer your account “as cash” or “holdings as is,” and depending on the investments you hold, there can be fees associated with choosing one over the other. We've got a handy little guide explaining the differences between the two right over here.
Death of a TFSA holder
Although no one likes thinking about these things, it’s important to know what happens if an account holder passes away. You’ll want to know specifically how this might affect TFSA taxations and whether the account will be dissolved or passed on. Knowing this information now and creating a plan will likely make life easier for everyone once the account holder passes away.
If an account holder named a designated beneficiary for their TFSA before they passed away, then they’ll receive the account and all of its holdings. The same goes for spouses, common-law partners, children, and anyone else named a successor holder. But the most important thing to know is that any income earned after the original holder’s death continues to be sheltered from tax under the new successor holder. So let’s say your spouse had a TFSA with $8,000 in it, and in the period between their death and the settling of their estate the account has earned $200 in income, both the $8,200 and any income earned on the account thereafter will remain tax-free.
However, if there were excess contributions in the TSFA at the time of the account holder’s death, then things get a little more complicated. Let’s say your partner, at the time of their death, had a TFSA excess of $2,000. If you get named your partner’s successor, then your partner’s $2,000 excess contributions are automatically transferred over to your own TFSA. If you still have contribution room to spare, you’re good. But if those extra $2,000 put you above your allotted annual contribution, then you’ll have to pay a 1% tax per month for as long as the excess remains in your account.
We know you probably have lots more questions about TFSAs which we’ll happily help with. We’ve tried to cover the most common TFSA questions people ask.
Common questions about TFSA contributions
Who can contribute to a TFSA?
In order to open and start contributing to a TFSA, you need to be a Canadian citizen, have a valid Social Insurance Number (SIN), and be at least 18 years old. As the account holder, you’ll be the only one who can make contributions, withdrawals, and determine how the funds will be invested.
Are TFSA limits cumulative?
Yes—TFSA limits are well and truly cumulative. Contribution limits refer to the maximum amount you can contribute to your TSFA each year, and contribution room automatically accumulates every year. You can also withdraw from your TSFA anytime you like, but remember that whatever amount you withdraw will be added on top of your annual contribution room for the next calendar year. Unused contribution room also carries over into the next year. Unlike RRSPs, you also can’t deduct the amount you contributed from your income in your taxes.
How much TFSA contribution room do I have?
This years contribution limit and any past contribution room you have not used. For 2019, the annual TFSA contribution room is $6,000. But your own individual contribution room is determined by the annual dollar limit (in this case $6,000), any unused TSFA contribution room from the previous year, and any withdrawals made from the TSFA in the previous year.
How can I claim TFSA contributions on income tax/tax return?
You can’t. TFSA contributions are not tax deductible like RRSP contributions and you can’t claim them on income tax returns. That’s because the TFSA contributions, interest/returns gained, and withdrawals are already exempt from taxation. The benefit of a TFSA is not that you can deduct contributions in your tax return but rather that the earnings in your TFSA can grow tax free.
Common questions about TFSA goals
Can a TFSA be used as an emergency fund?
Yes you can—there’s nothing stopping you. The money will grow tax-free, and withdrawals are free. The only thing you need to keep in mind is the contribution limit; if you withdraw from the account, you won’t be able to add the withdrawn funds back into your TFSA again until next year. As long as you’re able to stay within the contribution limits, there’s no reason why a TFSA can’t hold your emergency fund. However, TFSAs are usually used in conjunction with RRSPs to create a retirement fund or to save for another big purchase down the line. Words to the wise—it’s probably best to keep emergency funds in cash savings rather than in investments, since you want to be able to access your money whenever you need it and not face the possibility of withdrawing during a market dip. You could consider putting your emergency fund in a savings account and use your TFSA for longer term savings goals.
Can you use a TFSA to save for a vacation?
You absolutely can! The same logic as above regarding the emergency fund applies here as well, however. When you withdraw the money, you won’t be able to contribute it again until the following year. If you want to take a vacation in the near future cash savings might be a better option to avoid market swings. If you’re saving for the vacation of a lifetime in 10 years time then you could consider investing the money instead, depending on your circumstances.
Common questions about TFSA Investments
Can TFSAs hold US stocks?
TFSAs can hold US stocks, but you’ll need to keep an eye out for taxes. America taxes dividends on US stocks held in TFSAs. There’s a 30% withholding tax on any US stock dividend, only half of which can be claimed as a deduction on your tax returns. So effectively, you’ll be paying a 15% tax on dividends.
Should I max out my TFSA?
There’s nothing speaking against maxing out your TFSA, as long as you have an emergency fund in place elsewhere. If you can afford to do so, filling up all of your available contribution space can really help you take advantage of a TFSAs tax benefits. Just make sure you’re keeping a very close eye on your contribution room and making sure you don’t over-contribute in the same calendar year if you withdraw and then plan to re-deposit funds.
Can you lose money in a TFSA?
It depends. Term deposits and cash in savings accounts are covered up to $100,000 under the Canada Deposit Insurance Corporation (CDIC). Investments are not covered by the CDIC. There is always an inherent risk of incurring losses when you’re dealing with investments. Depending on the type of investment held in your TFSA, you may incur a loss in your original investment. And keep in mind that any investment losses within a TFSA are not considered a withdrawal and therefore are not part of your TFSA contribution room. If you have a TFSA that comprises of GICs, stocks, bonds and mutual funds, only the GIC portion will be covered by the CDIC. To learn more about the CDIC and get up to date information on their coverage visit their website here.
Other Common questions about TFSA Accounts
How many TFSAs can one person have?
You can open as many TFSA accounts as you like, but be careful. The total contribution room of all accounts is the same as it would be if you only had one account. That means that if the contribution room for 2019 is $6,000, it’s $6,000 in total, regardless of whether you have one or five TFSAs. Multiple TFSAs can make it harder to keep track of contributions.
Can TFSAs be joint?
No, TFSAs can’t be joint. You are the sole holder of your TFSA account. That’s because everyone has their own individual contribution limit, and this cannot be combined with anyone else. You are, however, able to designate beneficiaries and successor holders to your TFSA.
Can TFSAs be used as collateral as a loan?
The assets within a TFSA can be used as collateral against a loan. A TFSA can, for example, be used to secure a mortgage or similar. This may come with the stipulation that you can’t withdraw funds from the TFSA until the loan has been paid off.
After contributing to a TFSA and RRSP what comes next?
First off, good for you! If you’ve been a busy saver and stocked up your emergency fund as well, and are contributing to an RRSP it’s time to start diversifying your investments further, if you haven’t done so already. A personal investing account, for example, can help you explore other investment opportunities once your retirement savings are in a good place. Also, if you have children, looking into a Registered Education Savings Plan (RESP) is a great way to start building up a strong financial foundation for them.
Ready to take five minutes to open the finest TFSA imaginable? Sign up to Wealthsimple, the only automated investing services to offer all of its client’s unlimited human support. Every Wealthsimple client gets state of the art technology, low fees and the kind of personalized, friendly service you might have not thought imaginable from a low-priced investment service.