How Does TFSA Work in Canada?

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A lot of investment options are available to Canadians to earn good returns on their enterprise. One such investment is a tax-free savings account (TFSA).

Unlike regular deposit accounts, TFSA is actually not a savings account but an investment account to grow your money on a tax-free platform. A tax-free savings account can hold many investment assets such as Bonds, ETFs, Stocks, GICs, and Cash. 

When considering putting your money in a TFSA savings account, it is essential to get the most out of your investment opportunities by putting your funds in a savings account that offers one of the best rates. The benefit of a TFSA savings account is that you do not pay taxes on the interests earned on your investment.

What is a Tax-Free Savings Account (TFSA)?

A Tax-Free Savings Account (TFSA) is a registered investment or savings account that allows for tax-free gains and withdrawals on contributions, dividends, and interests. Unlike a regular savings account where you have to pay tax on interest earned, a Tax-Free Savings Account (TFSA) lets you earn non-taxable interests.

In 2009, Canada’s federal government introduced the Tax-Free Savings Account to enable Canadians to save and invest their money for various purposes. The Canadian government designed the TFSA for individuals of the age of majority (18 years of age and older) with a valid Social Insurance Number (SIN).

Disclaimer: Rates and product offerings are always changing so this article might not reflect the current market situation. Please contact your financial advisor before making any financial decisions.

How Tax-Free Savings Account (TFSA) Works

When you invest in mutual funds, bonds, stocks, ETFs, and others, you’re required by law to pay taxes on any interest you earn on your investment. However, TFSA is a channel through which you can invest, earn interests, and pay no tax on your investment returns.

Compared to traditional savings accounts, you can get the higher interest and maximize your investment with a Tax-Free Savings Account. 

At its introduction in 2009, the contribution limit on TFSA was $5,000 per year. This limit was increased to $5,500 in 2013, and in 2019, the annual contribution limit was increased to $6,000 and remained at that rate to date.

Unlike an RRSP savings account, which is designed specifically for retirement, when you save money in a TFSA, you can withdraw your money at any time without paying taxes on it.

Contributing To Your TFSA

Tax-Free Savings Accounts lets you diversify your investments into different financial products such as Bonds, Stocks, ETFs, Guaranteed Investment Certificates (GICs), mutual funds, cash (savings account), securities, and more. When you put money in your TFSA, there is a contribution room and a contribution limit you need to be aware of. 

The contribution room is the maximum allowed contribution that you can deposit in your TFSA account. This limit is flexible, as it increases and accumulates every year.

All used contribution rooms from a previous year can be carried forward and accumulated to the following year. For instance, if you have $0 in your TFSA up until 2019, you are permitted to make the annual contribution limit of $6,000, as well as the cumulative contribution of $63,500.

YearTFSA Contribution
Limit
TFSA Cumulative
Room
2009$5000 $5000
2010 $5000 $10,000
2011 $5000 $ 15,000
2012 $5000 $ 20,000
2013 $5500 $ 25,000
2014 $5500 $ 31,000
2015$10,000 $ 41,000
2016 $5500 $ 46,500
2017 $5500 $ 52,500
2018 $5500 $ 57,500
2019$6000 $ 63,500
2020$6000 $ 69,500

Over-Contributing Your TFSA

Over-contribution occurs when you deposit more than the stipulated contribution room. If you over contribute your TFSA, exceeding the annual contribution limit, you will pay a fee of 1% of the total contribution amount monthly until its withdrawal. There’s no escape route from this. The CRA monitors your annual TFSA contributions and will ensure strict compliance and enforcement of the penalty.

Making Your TFSA Withdrawal

You can withdraw your money from your TFSA without losing your contribution room. Unlike RRSP, withdrawal on TFSA accounts can be made at any time. Any withdrawal amount from your TFSA is added to your annual contribution room at the start of the following year. When you make a withdrawal from TFSA, you will forfeit that year’s contribution room until the following year.

For instance, if you contribute $5000 in the year 2020 (the contribution limit for the year is $6000) and withdraw $1,500, you cannot replace your withdrawal amount in the same year 2020. This can only be done in 2021, which is the following year. 

The reason for this is because the available contribution room is $1000 ($6000 – $5000 = $1000). As a result, in the year 2020, you can replace the $1000 and wait till the following year to re-contribute the remaining $500. By that time, the withdrawal amount would have been added to your contribution room.

How to Open a Tax-Free Savings Account

There’s no limit to the number of Tax-Free Savings Accounts (TFSAs) you can open at any given time, as long as your total contribution is within the limit of your TFSA contribution room for each year.

Most financial institutions, credit unions, and insurance providers in Canada issue Tax-Free Savings Accounts (TFSA). When you use a traditional financial institution such as Canada’s Big Five, you rest assured of getting different investment packages in a secured TFSA account. However, you are most likely to get a meager interest rate on your investment, compare to the high-interest rates offered by online and digital banks, including Tangerine, Motive Financial, Oaken, etc.

Eligibility for TFSA

To open a Tax-Free Savings Account (TFSA) in Canada, you must contact your preferred financial institution or issuer and provide the necessary information for account opening, including your date of birth, personal information, and other necessary documents.

Also, to open a TFSA, you must:

  • Be a resident of Canada for tax purposes.
  • Be at least 18 years of age or older.
  • Have a valid Social Insurance Number (SIN)

Benefits of Having a TFSA in Canada

  • TFSA lets you enjoy tax advantage or tax breaks on your earnings.
  • TFSA encourages people to save more, especially towards retirement or other long-term goals.
  • TFSA enables you to set aside a certain amount of money for investments and watch it grow to earn non-taxable returns.
  • TFSA savings can be withdrawn from your account at any time, and all withdrawals are tax-free.
  • You can withdraw funds from your TFSA and re-contribute the following year without forfeiting your contribution room.
  • TFSA contributions accumulate annually; hence, contributions can be made at any time.

TFSA and RRSP                                          

You might have wondered why there’s a need to have two similar (but different) investment options to save for the future. Registered Retirement Savings Plan (RRSP) account is designed for retirement savings specifically. TFSA, on the other hand, has much usefulness. You can use TFSA for all types of investments and savings.

Some of the differences between a Registered Retirement Savings Plan (RRSP) and a Tax-Free Savings Account include:

  • RRSP is suitable for long term wealth building, while TFSA can be used for short, medium, and long term goals.
  • Interests and dividends earned on an RRSP account are subject to income taxes on withdrawal, unlike TFSA, which is tax-free.
  • Deposits to your RRSP accounts are tax-deductible, while TFSA deposits are not tax-deductible.
  • Withdrawals from an RRSP savings account are taxable income, while TFSA withdrawals are not taxable.

Best Tax-Free Savings Account (TFSA) Interest Rates in Canada

Some of the best Tax-Free Savings Accounts in Canada include:

  • Tangerine TFSA: 0.10% (standard) and 2.10% (promotional interest rate).
  • Alterna Bank TFSA: 2.00%
  • Implicity TFSA: 1.35%
  • People’s Trust TFSA: 1.35%
  • Motive financial TFSA: 1.550%
  • EQ Bank TFSA: 2.30%
  • CIBC TFSA: 1.50%
  • Scotia TFSA: 1.50%
  • Wealthsimple: 0.50%

Tax-Free Savings Account FAQs

How much can I put in a tax-free savings account in Canada?

The annual TFSA dollar limit for the year 2019 to date is $6,000. The TFSA annual room limit will be indexed to inflation and rounded to the nearest $500. Investment income earned by and changes in your TFSA investments’ value will not affect your TFSA contribution room for current or future years.

Can I have two TFSA accounts?

You can have more than one TFSA at any given time, but the total amount you contribute to all your TFSAs cannot be more than your available TFSA contribution room for that year. As the account holder, you are the only person who can contribute to your TFSA.

What is the lifetime limit for TFSA?

There is no lifetime contribution limit. If you have unused TFSA contributions, it will automatically carry forward indefinitely. After you withdraw money from your TFSA, you can recontribute the full amount of the withdrawal the following year.

Is a TFSA better than a regular savings account?

With a regular savings account, you have to pay tax on the interest you earn. With a registered Tax-Free Savings Account (TFSA), any interest you earn is non-taxable, and you can take money out of your TFSA at any time without paying taxes on it.

Do I have to report my TFSA on my tax return?

You don’t need to report contributions to, withdrawals from, or income from your TFSA on your tax return.

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Kareena Maya is a freelance writer focused on the personal finance and travel spaces. He frequently writes about credit cards, banking, student loans, insurance, travel rewards and more. His work has been featured in publications such as Forbes Advisor, Bankrate, Credit Karma, Finance Buzz, The Ascent and Student Loan Planner.

Kareena Maya is a freelance writer focused on the personal finance and travel spaces. He frequently writes about credit cards, banking, student loans, insurance, travel rewards and more. His work has been featured in publications such as Forbes Advisor, Bankrate, Credit Karma, Finance Buzz, The Ascent and Student Loan Planner.