How does a TFSA work?

Presented By
Scotiabank
A tax-free savings account should really be called a tax-free investment account—because it allows you to hold not only savings, but also stocks, ETFs and other assets.
Presented By
Scotiabank
A tax-free savings account should really be called a tax-free investment account—because it allows you to hold not only savings, but also stocks, ETFs and other assets.
One of the side-effects of working for a personal finance magazine is that my buds good-naturedly ask me for advice. I always oblige, albeit sheepishly, without letting on that I’m still learning, too (which I freely admit here). For instance, the other day I was having lunch with some friends when we started talking about money. The exchange went something like this:
Friend: Ugh, I’m so lost when it comes to money. What should I do?
One of the greatest mistakes young people can make right now (other than blow their money on something stupid, like, say, a house in Toronto) is not realize that their money can do more than just sit there.
Me: Well, do you have a TFSA?
Friend: Yes (in a proud voice).
Me: That’s great, you’re ahead of the game. What are you investing in?
Friend: W-w-what?
I then went on to explain what a TFSA really is. The tax-free savings account is NOT, I repeat, NOT just a savings account.
A tax-free savings account (TFSA) should really be called a tax-free investment account. That’s because it is a registered account that allows you to hold not only savings, but also stocks, mutual funds, guaranteed investment certificates (GICs), bonds and exchange-traded funds (ETFs). Inside a TFSA, all of your investments grow tax-free. Another bonus? Unlike with a registered retirement savings plan (RRSP), when you withdraw funds from your TFSA, you aren’t on the hook for taxes. That’s right: You don’t pay taxes on the growth inside your TFSA, and you don’t pay taxes when you take your money out of it.
Any Canadian over the age of 18 who has a valid social insurance number (SIN) is eligible to save or invest in a TFSA.
If you’re asking “What’s the catch?”—well, there isn’t one, unless you count the yearly limit for the amount of money you can deposit into the TFSA. Each year, the federal government announces what the annual maximum contribution is; for 2022, it’s $6,000, and for 2023, it’s $6,500. If you miss a year, or don’t make the maximum contribution, your unused contribution room can be rolled over into future years. So, if you turned 18 before 2009, the first year TFSAs were made available, your current lifetime maximum contribution room is $88,000, as of Jan. 1, 2023. When you withdraw money from your TFSA, that exact amount becomes available to you to contribute again as of the next calendar year. So, let’s say you withdraw $4,000 this year to fund a minor home renovation; next year, you’ll be able to contribute that year’s announced maximum plus the $4,000 you withdrew this year. (For a more precise look at how much you can contribute, enter your digits into our TFSA contribution room calculator.)
There is no limit to the number of TFSA accounts one person can have, but your total contribution limit remains the same, whether you have one TFSA or six. (The lifetime maximum for those who were 18 or older as of 2009 is currently $88,000 as of 2023.) The more accounts you have, the harder it is to keep track of them; there are penalties for overcontribution, too, so you’ll want to ensure you don’t exceed your annual or lifetime limit at any time.
You can hold the following qualified investments within a TFSA:
These are the safest vehicles for investing your money. Since savings accounts are essentially no-risk investments, because they are insured by the Canada Deposit Insurance Corporation (CDIC) or similar provincial bodies (check the details with your financial institution), they tend to pay a low rate of return compared to other investments. You can earn a little more interest with a high-interest savings accounts (HISA).
GICs are very safe, low-risk forms of investment with returns that are normally subject to tax at your marginal income tax rate unless they are held within a TFSA. GICs guarantee a rate of return for a fixed period of time, such as a one-year or five-year term. Non-redeemable GICs pay a higher rate of return in exchange for tying your money up for the entire term. If you think you might need to access your money before the end of the term, you can choose to hold cashable/redeemable GICs, which allow you to withdraw some or all of your investment at any time—but know that you’ll earn a lower rate of return with these types of GICs.
Investing in the stock market has the potential to pay a sizeable return on a small investment. However, stocks and bonds are also subject to a high degree of risk. While they can be held within a TFSA, they require both a higher financial aptitude and a higher risk tolerance than other investment options.
An ETF is a basket of investments that’s usually pegged to follow a particular market index. They can be a mix of different stocks, bonds, commodities or all of the above. They are bought and sold on an exchange, so you need a brokerage account to trade them individually, but they also work well as a complement to automated robo-advisors, such as Wealthsimple or Questwealth, since they are designed to be fairly hands-off. ETFs pay a moderate return for a moderate risk, and because they are not actively managed, they come with relatively low fees. Since ETFs do track the stock market as a whole, they are subject to the volatilities of the market and are better used as long-term investment tools, so your portfolio has a chance to rebound from any losses.
Similar to ETFs, these popular investment funds are diverse collections of stocks, bonds and commodities. However, rather than passively following the market or a particular index, mutual funds are actively managed by a portfolio manager, through your financial institution or by a robo-advisor. Because mutual funds are actively managed, they generally carry higher fees than stocks or passively managed investments such as ETFs; it’s important to pay attention to returns after fees when you’re deciding which funds to invest in. The degree of risk and potential return varies with the mix of assets held inside the fund. Like all investments held within a TFSA, earnings on mutual funds will not be taxed. There are many funds to choose from, depending on your risk tolerance, and they can be a sound hands-off option for long-term investments.
Compare the best TFSA rates in Canada
The great thing about TFSAs that’s particularly helpful for young people with shorter-term savings goals is that you can withdraw the money at any time without getting dinged or taxed or levied in any way. Pretty sweet.
I opened up a TFSA in high school at the behest of my father. When I was growing up, we’d seen financial hardship, and he didn’t want me to have the late savings start that he did when he came to Canada in his mid-30s, family in tow. I bought some mutual funds and contributed $25, then $50 a month from my meagre part-time-job paycheques. I can’t say I paid much attention or really cared about the growth I was seeing. But I felt good knowing that I was doing something. And it was comforting to me in university, when I panicked about graduating only to be unemployed and have no income.
I was lucky to have my father instil the importance of growing my money at that age, so I was aware of the investing powers of the tax-free SAVINGS account.
If you’re a newbie (like me) and this is new information to you, go forth and buy some investments! Your TFSA could be growing your money, not just hoarding it for safekeeping.
Both TFSAs and RRSPs are long-term savings vehicles for Canadians, which offer some tax protection. With TFSAs, you pay income tax on the money you invest when you earn it, but you do not pay taxes on the returns that accrue within the TFSA, not even when you withdraw them. In contrast, the earnings on RRSP investments are tax-deferred in the year that you earn and contribute, but they’re subject to income tax when withdrawn. RRSPs are a good choice for high-income earners who expect their retirement income—and, thus, the tax they end up paying—to be lower than their current income. For others, TFSAs may be a better choice.
This is an editorially driven article or content package, presented with financial support from an advertiser. The advertiser has no influence on the creation of the content.
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I learned something new today.
Thank you!
Great information Prajakta! Yes, we advise clients that a TFSA should always be MAXED
first before considering any other investments. Why? Simple: Tax Free Money for Life!
Cheers – Chris from ProLaunch in Ontario.
Great information , easy read and great references.
Thank you
Just how do you do investments from your tfsa?
Oaken Financial Canada and Accelerate Financial, Winnipeg also offer very attractive short & long term GIC rates. I find these two online providers extremely friendly and very easy to administer.
This product is the last haven of tax free earnings in Canada. And probably the only way that any of us can really keep our money, but it is under attack. Recently the CRA has flagged market-linked TFSAs to check how many trades you make in a year. If they discover you day trade, or make many trades (number undisclosed), and earn a large capital, they will tax 50% of those earnings at the marginal tax rate!! This is sneaky and completely unfair. The Government touts this as a savings vehicle, but punishes anyone who tries to get ahead. We as Canadians cannot be silent about this. The CRA and any new government will continue to chip away at this account until there’s no benefit left for us. They need to reverse this rule.
I understand that a spouse can be given successorship rights and therefore no problems. But can children be subsequently named as beneficiaries. What are the tax consequences if any then?