What is a Tax Free Savings Account (TFSA) and how does it work?

In Canada, a Tax Free Savings Account (TFSA) is a quintessential way to grow your savings and investments tax-free. If you are wondering how to use a TFSA, how to open a TFSA, or the benefits of these accounts, you certainly are not alone. This guide will provide a concise summary of a TFSA and how it works.

How does a Tax Free Savings Account work?

A TFSA allows you to put money into savings and investment which will grow tax-free. This includes interest, dividends, and capital gains. As a result, there is a yearly limit on contribution. 

Note: Contributions into the account are after tax but growth within the account is tax-free.

Despite it's name, Tax Free Savings Account, the account can be used for more than just cash savings. You can use it to invest in exchange traded funds (ETFs), guaranteed investment certificates (GICs), stocks, and more. The key part is that all these options can grow in your TFSA tax-free.  

At the end of the day, it's a highly-effective tool for long term savings. 

Who can open a TFSA?

Canadians over 18 with a valid SIN number can open a TFSA. The account is available in many forms (Savings, Investing, etc.) across many major financial institutions.

Can you day trade in a TFSA?

Day trading refers to actively using an account (on a daily basis) for investing. While there are no set rules, the CRA states that these accounts are for long term savings and any daily trading can be subject to penalties. 

Can a TFSA earn interest?

A TFSA can be opened as a savings account for earning interest or as an investing account to get a higher rate of return. This depends on your short-term and long-term financial goals.

If you are looking at a TFSA for earning interest, the first question on your mind is probably, "How do I get the highest possible interest rate?".

While competitive interest rates are important, it is best to look at other factors too such as the ease of withdrawing money from your savings account or whether their is a local branch. For a summary of best rates across Canada, check out this updated comparison of best high interest Savings Accounts in Canada. 

If you will be putting a sizable amount of money in a TFSA (or any other investment account), it's always best to consult a financial expert.

Can you have more than one TFSA?

You can set up more than one TFSA account (for Investing, Savings, etc.). But even with multiple accounts, your contribution room remains the same. Multiple accounts does not mean more room. The funds within multiple accounts should not surpass your contribution limit. Surpassing it will result in a penalty. 

When did the TFSA program start?

The TFSA program began in 2009. 

How do you withdraw from a TFSA?

This depends on your provider. In most cases, you can withdraw money from the account anytime you want.

Note: If you max out your TFSA for the year and decide to withdraw money, you cannot re-deposit that amount within the same year (without penalty). That amount can only be added the following year when the contribution room opens up again. 

Can I Transfer from an RRSP to a TFSA?

While specific details may depend on your provider, in most cases, you can make the transfer without penalty fees. It is important to note that you will pay taxes on the money withdrawn from the RRSP as though it were income for that year.

What is my TFSA limit?

It changes from one year to another. The contribution limit is $6,000 for 2021. If you have never contributed since the program began, you would have $75,500 in accumulated contribution room. 

Can I lose contribution room in a TFSA?

Money lost in a TFSA (for example, to a poor investment decision) cannot be regained in contribution room. 

What is the Lifetime Limit for TFSA?

There is no lifetime limit for TFSAs. 

Do you have to claim TFSA on your Income Tax Return?

No.

When can you contribute to a TFSA?

You can contribute to a TFSA between January 1st and December 31st of any year.

When does TFSA contribution room reset?

It resets on January 1st of every year. 

Are you incorporated in Canada?

Small business owners in Canada can use a Health Spending Account (HSA) to save on their medical expenses. An HSA is a cost effective alternative to traditional health insurance. The plan covers a wide variety of health and dental expenses. You could save thousands of dollars in taxes with an HSA.

Find out more about Health Spending Account (HSA), download my free guides: