A Tax-Free Savings Account (TFSA) is a tax-advantaged account offered in Canada that allows the account holder to avoid taxes on any interest earnings, capital gains, or dividends earned on contributions held within the account.
These accounts are available to Canadians ages 18 and older with valid Social Insurance numbers (SIN). They can be opened at almost any major financial institution across Canada.
Despite the name, Tax-Free Savings Account contributions don’t exclusively have to be held in cash. Depending on the type of TFSA you have, you may be able to choose from a variety of mutual funds, guaranteed investment accounts, government bonds, and even publicly traded stocks.
Let’s learn more about these savings vehicles by reviewing their details, their pros and cons, and how contributions and withdrawals are made.
What Is a TFSA?
TFSAs, or Tax-Free Savings Accounts, are excellent tax-sheltered accounts that allow contributed funds to grow-tax free. That means no taxes on interest earnings, dividends, or capital gains. What’s more, funds can be withdrawn at any time without penalty for account holders. This is a key difference between TFSAs and retirement savings plans, which are designed to be held till a certain age.
If you compare TFSAs to Registered Retirement Savings Plans (RRSPs), you’ll see that TFSAs allow you to withdraw your contributions and any subsequent earnings over time, tax-free. With RRSPs, a certain percentage of any withdrawals taken out prior to retirement may be withheld.
To look at this from a different angle, any funds contributed into a TFSA can be withdrawn on demand and are not subject to taxation or penalty, as long as all contributions remain beneath your overall TFSA contribution limit. This makes them an excellent tax shelter for both short-term and long-term financing needs.
We’ll run through how these accounts work, their benefits, limitations, and everything else you need to know about TFSAs.
How Do TFSA Contributions Work?
Tax-Free Savings Accounts allow you to contribute a finite amount, set annually by the Canada Revenue Authority (CRA). As mentioned above, your funds within the TFSA can earn interest, earn dividends and even capital gains without being taxed. The 2022 contribution limit for TFSAs is $6,000. This makes them excellent financial vehicles when it comes to the important goal of saving for the future.
TFSA limits accumulate and carry over every year. This means that your contribution limits (commonly referred to as your “contribution room”) will stack up annually. This holds true whether or not you’ve completed a Canadian income tax return or even have an existing account at the time. In other words, if this year’s contribution limit is $6,000 and you only contribute $4,000, next year you can save an extra $2,000 over the limit to catch up. So if the limit for the following year was $6,000, your contribution room will be $8,000 (adding the $6,000 and the additional $2,000).
In fact, you’re allowed to make retroactive contributions for all of the cumulative annual contribution limits dating back to 2009, or when you first turned 18, whichever was more recent.
Make sure you keep track of your overall contributions, as accidentally overcontributing to the account can result in tax penalties. According to the CRA, overcontributions are subject to a 1% penalty tax on the overcontribution amount each month until it’s withdrawn from the account.
To contribute to a TFSA, you’ll want to first figure out what your current annual contribution limit is and then calculate how much additional contribution room you have from years past where you didn’t hit the limit. By the way, there’s no earned income requirement for contributing to a TFSA.
To help you calculate your total TFSA contribution limit, we’ve provided a table below that outlines all of the annual contribution limits since the program was established in 2009. We’re also sharing a cumulative contribution limit to help you back-date your permitted total contribution amount.
| Year | Annual Limit | Total Accumulated Limit |
|---|---|---|
| 2009 | $5,000 | $5,000 |
| 2010 | $5,000 | $10,000 |
| 2011 | $5,000 | $15,000 |
| 2012 | $5,000 | $20,000 |
| 2013 | $5,500 | $25,500 |
| 2014 | $5,500 | $31,000 |
| 2015 | $10,000 | $41,000 |
| 2016 | $5,500 | $46,500 |
| 2017 | $5,500 | $52,000 |
| 2018 | $5,500 | $57,500 |
| 2019 | $6,000 | $63,500 |
| 2020 | $6,000 | $69,500 |
| 2021 | $6,000 | $75,500 |
| 2022 | $6,000 | $81,500 |
If you turned 18 in 2009 or prior and have just begun making contributions this year, your total permitted lifetime contribution limit is $81,500. If you turned 18 after 2009, your contribution room (or limit) will be the sum of the cumulative amounts for all years starting from when you first turned 18.
How to Withdraw Money From a TFSA
When thinking about different types of savings accounts, you may wonder how a TFSA stacks up in terms of how you can withdraw funds. Let’s explain: You can withdraw both contributions and earnings from your TFSA at any time, without fear of tax penalty. Withdrawals are only logged when you transfer or take savings out of your TFSA, so if you convert your investments into cash and the money remains in your account, this won’t be counted as a withdrawal.
You can withdraw any amount up to the entire balance of your TFSA account (though obviously, you’d like to avoid overdrafting a savings account). One of the best aspects of TFSA withdrawals is that the amount of any withdrawn contributions is automatically added back to your total TFSA contribution room for the following tax year.
However, if you reach your contribution limit in a given year, you won’t be able to make any additional contributions during that year, even if you decide to withdraw funds from the account. Contribution rooms are only recalculated after the beginning of the following year.
Withdrawals can typically be done easily online; check with your account holder for details.
Pros of a TFSA
We’ve highlighted some of the advantages of a TFSA, but let’s run through the main ones here:
• Tax-exempt interest and investment earnings: TFSAs are excellent places to park excess savings to earn a higher rate of return without having to worry about taxes on interest and capital gains. These tax advantages can be a bonus over the way savings accounts typically work.
• Withdrawal and use flexibility: Unlike RRSPs which may incur a penalty when withdrawn prior to retirement, TFSAs have no restriction on the use of the underlying funds.
• Contribution limits rise annually and do not expire: This means that you won’t miss out on any opportunities to add to your TFSA, even if you don’t have any income to add to your account in the current year.
• Wide range of permitted investments: Unlike what the name suggests, funds deposited in a TFSA can be invested in stocks, bonds, mutual funds and other investments as permitted by the issuing institution.(Remember, though, that these investments may not be insured.)
Cons of a TFSA
Yes, there are some downsides to be aware of with TFSAs. Consider these three points:
• Non-deductible contributions: All contributions to TFSAs are made on an after-tax basis. As a result, TFSA contributions can’t be used to reduce your taxable income.
• Day-trading is not permitted: The CRA discourages day-trading in your TFSA account. Depending on the frequency and type of trading activities within your account, it may declare your investment returns to be taxable business income if you’ve failed to follow the rules.
• Not bankruptcy-remote: Unlike RRSPs which are protected from creditors, TFSAs are subject to the whims of any creditors that may seek to pull your assets back in court. This means that the funds in TFSA are fair game in bankruptcies.
Typical Steps for Opening a TFSA
You can open a TFSA at most major financial institutions in Canada. They’re available at banks, credit unions, and even insurance companies. Some offerings may differ slightly in terms of their permitted investments, so it pays to shop around for the one that best suits your financial goals. Here are the five typical steps to opening a TFSA:
1. Shop around for a financial institution that offers TFSAs; make sure it fits your needs and investing style. The following are the types of TFSA accounts available:
a. Deposit
b. Annuity
c. Trust arrangement
d. Self-directed TFSA
2. Once you’ve decided on the right TFSA, contact your chosen institution directly and apply for an account.
3. As part of the application process, the institution (issuer) will ask for some personal information. Make sure to have the following items available:
a. Birthdate
b. Social Insurance number
c. Government-issued ID
4. After you’ve provided all the necessary documentation and are approved, your issuer will register the account as a qualifying arrangement with the CRA.
5. You can then set up funds transfers or direct deposits into your TFSA account whenever you’re ready.
Congratulations, you now have a newly formed TFSA!
Keep in mind that while there’s no restrictions on the number of Tax-Free Savings Accounts you can have, your total contribution limit will be shared across all your accounts. Additional TFSAs will not increase your total contribution room.
All contributions will be reported to the CRA by your issuing institution, so remember to keep track of your contributions to avoid running afoul of the tax rules.
The Takeaway
Anyone who can afford to should consider taking advantage of a Tax-Free Savings Account. TFSAs are versatile tax-advantaged accounts that can be used for both short-term and long-term savings needs. They provide an excellent tax-shelter for your investment earnings that can accumulate over time and be applied to a variety of needs. For those looking for a great savings vehicle, this could be it.
For those who are searching for a great day to day banking partner, we’ve got a great option, too. The SoFi Checking and Savings online bank account offers those who sign up with direct deposit a competitive APY to help your money make more money. There are plenty of other perks, too, like no fees (no monthly or minimum balance ones, and we’ll even give you up to $50 overdraft coverage without a fee).
FAQ
Can you lose money in a Tax-Free Savings Account?
Yes, depending on the underlying investments, there’s a possibility that you may lose the principal on your investment. When the principal is invested in securities like stocks, bonds and mutual funds, it is not covered by the Canada Deposit Insurance Corporation (CDIC). However, any uninvested cash in your TFSA is insured for up to $100,000 under the CDIC.
How do tax-free savings work?
Interest, capital gains, and dividends earned in a Tax-Free Savings Account aren’t taxed as long as you adhere to guidelines set by the CRA. As long as you remain beneath the contribution limits and don’t run afoul of any TFSA rules, earnings from your TFSA account won’t be treated as income.
Keep in mind, some exceptions, like dividends earned from U.S.-based equities may still be considered taxable income. You’ll want to thoroughly review and understand the investment guidelines set by the CRA when planning your portfolio.
Is a Tax-Free Savings Account worth it?
Depending on your particular situation and goals, it can indeed be worth it. Your interest, dividends, and your capital gains will grow tax-exempt, and you won’t pay taxes on any withdrawals.
SoFi members with direct deposit can earn up to 4.20% annual percentage yield (APY) interest on Savings account balances (including Vaults) and up to 1.20% APY on Checking account balances. There is no minimum direct deposit amount required to qualify for these rates. Members without direct deposit will earn 1.20% APY on all account balances in Checking and Savings (including Vaults). Interest rates are variable and subject to change at any time. These rates are current as of 4/25/2023. There is no minimum balance requirement. Additional information can be found at http://www.sofi.com/legal/banking-rate-sheet.
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