Tax-Free Savings Accounts in Canada: What to Know - NerdWallet (2024)

The federal government introduced Tax-Free Savings Accounts in 2009. This type of bank account quickly became popular with investors since it was a savings vehicle that allowed people to tax-shelter their money. More than half of Canadians (63%) have a tax-free savings account, according to BMO’s 2022 annual savings study.

Knowing more about TFSA accounts can help you decide how to invest in them and maximize their financial benefits.

What is a tax-free savings account?

A tax-free savings account, or TFSA, is a registered plan that allows Canadian adults with a valid Social Insurance Number (SIN) to save a certain amount of money each year without paying taxes on the earnings. The average TFSA holds $34,917, according to the 2022 BMO savings study.

A TFSA is similar to other registered plans, such as a Registered Retirement Savings Plan, or 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tax break when you contribute, you would not pay any capital gains tax to the Canada Revenue Agency (CRA) when money is withdrawn.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. TFSAs also ca be used to hold investments, like mutual funds and guaranteed investment certificates (GICs). All of your savings and investments are entirely tax-free when held in a TFSA.

TFSA vs savings account

Similar names aside, there are a couple of other fundamental differences to take note of.

• Tax benefits. TFSAs offer tax-free interest and investment gains. Regular savings accounts don’t.
• Contribution limits. TFSAs have annual contribution limits, while regular savings accounts don’t limit how much you can deposit.

What’s the bottom line? Both savings accounts and TFSAs hold cash and earn interest, but TFSAs offer unique tax advantages and are equipped to invest.

Tax-free savings account interest rates

Like standard savings accounts, TFSAs earn interest — though rates are variable and are subject to change. The average rate for a TFSA is 2.60% at the time of this writing, according to NerdWallet analysis.

Some TFSAs have interest rates as high as 4.10%, though these are often offered by digital banks or online divisions of in-person banks and credit unions.

TFSA key takeaways:

• Contributions to TFSAs earn interest like a regular savings account.
• TFSA contributions may also grow if you invest through your account as well as your investments perform.
• Although you don’t get a tax break when you contribute, you won’t pay any taxes on earned interest or investment gains in a TFSA.

How to use a TFSA

The way you use a TFSA depends on your needs and future financial goals. Some people use it for short-term savings, such as an emergency fund or a down payment. Others use it for longer-term goals like retirement savings or investing in the stock market.

If you have a savings goal in mind, using tax-free savings accounts can be an effective tool to accomplish it. This strategy allows you to purchase investment products within your TFSA that line up with your goal’s timeline and potential for risk.

For example, if you’re saving up a down payment and plan to buy a house in five years, your strategy would be different than if you’re saving for retirement in 30 years.

What can I invest in with a TFSA?

There are numerous options for those who want to invest through their TFSA, including:

• Stocks.
• Bonds.
• Mutual funds.
• Guaranteed investment certificates.

With the ability to invest through a tax-free savings account, you can choose to open 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 (EFTs), bonds, and more. Additionally, a self-directed TFSA allows you to be in total control of the investments you choose.

How to determine the TFSA contribution room

TFSAs have annual contribution limits. For 2023, the TFSA contribution limit is $6,500.

If you were eligible to contribute in previous years but didn’t have the cash, 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 2023, the TFSA total contribution limit is $88,000.

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. However, since financial institutions typically only report your contributions once a year, the number 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:

You can also use NerdWallet Canada’s TFSA contribution room calculator to help you find your TFSA contribution room amount to date.

Is there a penalty for TFSA over contribution?

Overcontributions 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.

Does withdrawal from TFSA 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 2022 and then withdrew $10,000 in November. On January 2, 2023, you’d be able to contribute $16,500: your $6,500 contribution for 2023 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 investments in your TFSA to reinvest the available funds doesn’t count as a withdrawal.

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?

Opening a TFSA is easy, as most financial institutions, insurance companies and investment firms offer them.

To open a TFSA you’ll need to:

• Be a resident of Canada.
• Be 18 years or older, or the age of majority in your province.
• Have a valid SIN.

The age rule is based on your actual birthday, 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, 2023. You’d be able to open a TFSA and contribute the full amount for the year ($6,500) on that date.

Is a TFSA worth it?

A tax-free savings account can be a great savings vehicle for investors looking for registered options to maximize their tax-free earnings. Although, you may want to weigh out its pros and cons as well as evaluate other investments, such as RRSPs.

TFSA Pros and cons

Once you understand how TFSAs work, you’ll quickly realize the benefits. Even though a TFSA can be a right fit for many people, there are still some drawbacks to consider.

TFSAs vs RRSPs

RRSP and TFSA are government-registered accounts designed to help you save and invest. And they both offer tax benefits — but the nuance of how these benefits work is what differentiates RRSPs and TFSAs. Knowing what sets these accounts apart can help you determine how to best utilize each one.

You may choose an 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 both.