Understanding Tax Free Savings Accounts (TFSAs)

If you’re looking for a tax-free way to save and invest, a Tax-Free Savings Account (TFSA) might be the way to go. Let’s look at what this account is and how you can use it to invest for your short- and long-term goals.

What is a TFSA?

A TFSA is a registered account introduced in 2009. TFSAs allow for tax-free growth of investment income and capital gains from qualified investments. Unlike RRSPs, contributions to TFSAs are not tax-deductible, but withdrawals from your account are tax-free.

The federal government sets the annual TFSA contribution limit – and you don’t lose it if you don’t use it. Any unused contribution room accumulates each year and you can “catch up” any year in the future. There are some rules around the timing of contributions and withdrawals that we’ll cover in this article.

Investment choices for your TFSA

Like most investment accounts, you can hold stocks, options, exchange-traded funds (ETFs), mutual funds, bonds and guaranteed investment certificates (GICs) in a TFSA, so long as they are qualified investments.

• Note: If you choose to hold foreign investments in your TFSA, many governments — including the U.S. — apply a non-resident withholding tax to foreign source income. Withholding taxes are unrecoverable, and may reduce your potential returns. For example, the IRS imposes a 30% withholding tax to dividends paid on U.S. stocks – which can be reduced to 15% by submitting a W-8BEN or W-9 form. Check with your tax advisor to learn more.

Who can open a TFSA?

Any Canadian resident with a Social Insurance Number who has reached age of majority in their province can open a TFSA. There’s no age limit for a TFSA either – you aren’t required to collapse it at a certain age.

Note that the age of majority is 19 in Newfoundland and Labrador, New Brunswick, Nova Scotia, British Columbia, Northwest Territories, Yukon and Nunavut. Contribution room starts at age 18, however, regardless of your province of residence. So if you’re a resident of Newfoundland, you can still contribute the same amount as a resident of Ontario – you just need to wait until age 19 to open the account.

Contributing to a TFSA

Everyone who is eligible can contribute to a TFSA, up to the annual limit determined by the federal government. Unused contribution room is also carried forward each year. As of 2021, for example, the TFSA cumulative limit (if you’ve never contributed and were 18 or older in 2009) is $75,500.

Annual contribution limits are based on the following:

• Federal government-set annual contribution limits (subject to change):
• 2009 to 2012: $5,000
• 2013 and 2014: $5,500
• 2015: $10,000
• 2016 to 2018: $5,500
• 2019 to 2021: $6,000
• Any unused contribution room carried forward from previous years
• The net of any withdrawals or re-contributions made in previous years

Example: 
If you contributed $4,000 to a TFSA during 2020, you would be able to carry forward $2,000 in unused contribution room. This means that in 2021 you would be able to contribute $8,000* to your TFSA.

• Contribution limit in 2020 = $6,000
• Your contribution in 2020 = $4,000
• Unused contribution for 2020 = $2,000
• Your contribution limit in 2021 = $8,000 ($6,000 annual limit for 2021 plus $2,000 in unused contribution from 2020).

*Assumes that you have maximized your annual allowable contribution since 2009.

Overcontributing to a TFSA

Excess contributions are subject to a tax of 1% per month, for each month that the excess amount remains in the TFSA. Interest and capital gains earned on the excess may also be penalized.

To view your TFSA contribution room, including any excess contributions, visit the My Account for Individuals section of the CRA website.

Withdrawing from a TFSA

You can withdraw from your TFSA at any time, for any reason. Withdrawals aren’t considered income for tax purposes, and you don’t lose contribution room.

Here’s how it works: any withdrawals you make in the current calendar year are added to your unused contribution room. You will need to wait until the next calendar year or later, if you wish to re-contribute the money.

Here’s an easy formula when thinking about your contribution room with an example:

Unused TFSA contribution room to date + total withdrawal made this year + next year’s TFSA’s contribution limit = TFSA contribution room at the beginning of next year.

Example: 

• Assume you had unused TFSA contribution room of $10,000
• January 2020: You contribute $6,000
• July 2020: You withdraw $2,000
• 2021 TFSA allowable contribution limit = $6,000
• Contribution room in the beginning of 2021 = $4,000 unused contribution ($10,000 - $6,000) + $2,000 withdrawal + $6,000 2021 limit = $12,000

Who uses TFSAs?

Younger investors who are starting to save

If you’re still in school, recently graduated or starting your career, a TFSA is one way to save for short-term goals such as a new car or a vacation. Its tax-free compound growth may help you achieve your savings target – and if you’ve withdrawn the money to make a purchase, you can re-contribute it to the plan in a future year. If you’re investing for retirement, a TFSA also allows you to preserve your RRSP contribution room for a later year, when you may be earning more and benefit more from an income tax deduction.

Career builders

Your annual income may increase as your career advances. If you’ve maximized your RRSP contributions, you can keep saving tax-free with a TFSA. A TFSA can be useful to save toward important personal goals like buying or renovating a home. And if you have an unexpected financial emergency, you can withdraw funds without tax penalties.  

Retirees and pre-retirees

There is no requirement to close your TFSA at a certain age. So, retirees — who must begin drawing on their registered retirement savings at age 71 — can use their TFSA to continue saving. If you're unable to contribute to an RRSP because of your age or because you have no qualifying income, a TFSA allows you to benefit from tax-free compound investment growth. If you’re receiving income from a pension plan or Registered Retirement Income Fund (RRIF), you can contribute any unused funds to a TFSA to generate tax-free income.

For some examples on how you might use a TFSA, read How Do You Use Your TFSA? 3 Personal Stories

Feeling overwhelmed by the account choices when it comes to your savings goals? Check out TFSAs, RRSPs and RESPs: How do they compare?

To open your TFSA

If a TFSA is the right choice for you, click here to open your account.

The information provided in this article is for general purposes only and does not constitute personal financial or tax advice. Please consult with your own professional advisor to discuss your specific financial and tax needs.