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Understanding TFSAs: The basics

With many Canadians unsure about what a TFSA is or how it works, we'll get you started with the basics.

Updated
12 min. read

One in three Canadians still wonder, what exactly is a TFSA? footnote star

Of all the saving and investment options available to Canadians, the TFSA (Tax-Free Savings Account) might be the least understood. A TFSA is a registered investment savings account that can be opened by any Canadian resident who is 18 or older and has a valid social insurance number. Though it can certainly be used as a straightforward savings tool, its name is a bit of a misnomer as TFSAs are increasingly employed to hold investments. In fact, it can store a variety of investments like cash, exchange-traded funds (ETFs), guaranteed investment certificates (GICs), bonds, stocks and mutual funds.

Of course, this is just the tip of the iceberg on understanding TFSAs; if you have further questions, be sure to consult with an advisor.

Let’s start with the fundamentals:

Introduced in 2009, a TFSA is a type of registered savings plan in which any investment income you earn is tax-free footnote star, star. The amount invested inside your TFSA can be withdrawn, also tax-free footnote star, star. (When you can withdraw funds will be determined by the terms of your investment.) Anyone 18 years of age or older and a Canadian resident with a valid Social Insurance Number (SIN) can open a TFSA. However, if you’re in a province or territory where the age of majority is 19, you may need to wait an extra year before you can open a TFSA, though your contribution room will carry over from when you were 18.

Whether or not you’ve contributed to a TFSA, you’ve been accumulating contribution room since it came into being in 2009, assuming you were 18 and over and a Canadian resident. Every year the CRA determines the annual limit. If you haven’t met that limit, the unused portion is forwarded onto your personal limit for the next year. Effectively, your contribution room carries forward indefinitely. 

Say, for example, that you just opened a TFSA in January 2024. Since you haven’t contributed anything since 2009 (assuming you meet the eligibility criteria), as you’ll see with the calculations below, you have the right to deposit a total of $95,000 into the account this year.  

What’s the difference between an RRSP and a TFSA?

Think of it like this: with an RRSP (Registered Retirement Savings Plan), you don’t pay tax on money that goes in because you are entitled to a tax deduction on contributions, but you do pay tax on money that comes out including any income or gains realized within the RRSP.

Unlike registered retirement savings plans (RRSPs), contributions into a TFSA won’t reduce your taxable income (the money you put into the TSFA has already been taxed). But, as your financial advisor or accountant will tell you, where you do enjoy tax relief is in the fact that any income earned from your TFSA is not taxable.  

With a TFSA, it’s the opposite. You’ve already paid tax on the money you put into it since contributions are not tax-deductible, which means you don’t pay tax when you make a withdrawal including any income or gains realized within the TFSA.

Therefore, a TFSA is a great option when you want to withdraw funds. Here’s another example: if you plan to take out money before retirement, a TFSA will let you do that without tax consequences. Another difference is that, unlike an RRSP, you can keep contributing as long as you live, with no need to collapse it at a set age.

What else do you need to know about TFSAs?

Don’t let the “tax-free” part in Tax-Free Savings Account confuse you

Unlike an RRSP, the money you put into a TFSA is not tax-deductible; therefore it doesn’t reduce your taxable income (to potentially put you in a lower tax bracket). For instance, if you make $50,000 this year, and you decide to put $10,000 into a TFSA, your taxable income doesn’t become $40,000. This is a common misunderstanding.

Don’t let the “savings” part in Tax-Free Savings Account limit you

Although the TFSA is a type of registered savings plan, there’s so much more to it than just a savings account; the TFSA is so adaptable, in fact, the letter F in the name might as well stand for Flexible. If you’re looking to invest in your TFSA for the short term – to buy a car, let’s say – a TFSA may be a good choice. And if you’re looking to invest for the long term in your TFSA – for example, to buy a vacation home down the line – a TFSA can help you with that too.

Where are you in life? And how can a TFSA help?

I’m just starting out. If you’re a young investor, you’re likely hoping to pay down your student loans, plan for a wedding, or save for a down payment on your first home. Because your earnings in a TFSA are tax-free footnote star, star, your savings grow faster. The benefit: you can withdraw money without tax consequences whenever you need to, and recontribute later in the same year if you like (if you still have contribution room remaining).

I’m comfortably settled into life. At this point in life, the future is what matters. You may be saving up for your retirement (especially if your RRSP contributions have been maxed out), or maybe a well-deserved vacation or home renovation. Your savings within a TFSA can be used however you wish, any time you wish – and remember, all potential returns are tax-free footnote star, star.

I’m happily retired. Congratulations! A TFSA could be just what you’re looking for to reinvest your mandatory Registered Retirement Income Fund (RRIF) withdrawals or any other income you may be receiving in retirement. A TFSA is also worth considering when looking to leave a legacy for your children or grandchildren.

“One in three Canadians still wonder, what exactly is a TFSA?”

TFSAs are a versatile way to invest

A TFSA can hold a wide range of investment vehicles. It all depends on your income, goals and tolerance for risk. For example, you can hold mutual funds, stocks, ETFs (exchange traded funds) and bonds in your TFSA. You can also hold GICs (Guaranteed Investment Certificates) and cash in a TFSA, but those may have a lower yield potential than the first four. Some investments are restricted however, so check with your financial professional footnote dagger.

TFSA tips, tricks and good-to-know info

Your current TFSA contribution room can be found by logging into the CRA My Account website. Keep in mind, though, that if you’ve contributed to your TFSA in the current tax year, that amount won’t be reflected in your total limit.  

Alternatively, you can calculate your TFSA contribution room by combining: 

  • The current year’s contribution limit. 
  • Unused contribution room from previous years. 
  • Withdrawals from previous years 

The following is a list of annual TFSA contribution limits per year since TFSAs were created. 

For the years 2009-2012: $5,000 

For the years 2013-2014: $5,500. 

For the year 2015: $10,000. 

For the years 2016-2018: $5,500. 

For the years 2019-2022: $6,000. 

For the year 2023: $6,500. 

For the year 2024: $7,000. 

The annual TFSA contribution (dollar) limit for 2024 is $7,000. If you don’t contribute the full $7,000, this leaves unused contribution room that accumulates annually (as it does with an RRSP). This means you can contribute more than the annual TFSA dollar limit each year, as long as you didn’t contribute the maximum in past years. To see how much unused contribution room you may have go to the following CRA services: My Account; MyCRA; Represent a Client; and Tax Information Phone Services.

Money for an emergency

We’ve mentioned this before but we can’t stress it enough: the TFSA is flexible. In many cases, funds are available in next to no time, and you don't pay taxes on those withdrawals (like you would on a withdrawal from an RRSP). Withdrawn funds will also result in additional contribution room the following year.

The high-interest rate savings account vs. a TFSA

The most obvious difference between the two is that you pay taxes on any income you earn within a regular high-interest rate savings account, whereas in a TFSA you don’t. You may want to consider putting money from any taxable accounts into a TFSA as part of your overall investment strategy. Again, this might be something to discuss with your financial professional.

You can use your TFSA as loan collateral

Yes, it’s a little known fact but it’s true. You can use the assets inside your TFSA as collateral for a loan (whereas you can’t with an RRSP). This can come in handy if, for example, you have money tied up in your TFSA inside a locked-in GIC: you can’t unlock it, but you can use it as collateral.

How a TFSA affects capital gains and losses

If you earn capital gains on stocks, ETFs or mutual funds held outside a TFSA, you could be taxed on 50% of the total gain (less any capital losses) for the year. However, if you hold those investments in a TFSA, any capital gains you earn are tax-free footnote star, star. Capital losses, on the other hand, cannot be claimed if they occur inside a TFSA.

TFSA withdrawals don’t affect government benefits and credits

When you take money from a TFSA, it doesn’t count as income. That means you don’t pay tax on it, it doesn’t affect your GST credit or Employment Insurance, and you won’t suffer clawbacks on your Guaranteed Income Supplement or Old Age Security.

Over-contributions: Be sure to know the rules

If you withdraw money out of your TFSA, you can recontribute it, but only if you have contribution room available. If not, you will have to wait until the next calendar year. If you contribute during the same year and surpass your limit, you’ll be subject to a tax each month on the amount of the over-contribution.

Let’s look at an example. Kristina opened her TFSA in 2012 and has contributed the maximum dollar limit every year since. That gives Kristina a total of $88,000 in her TFSA account by the end of 2023. When 2022 comes, she contributes $6,000, the top dollar limit for that year. Suddenly, Kristina sees the opportunity for the trip of a lifetime, so she withdraws $3,000 to travel. Then, just as suddenly, she discovers she can’t go.

She simply can’t put that money back into her TFSA. Because she’s already maxed out her TFSA contribution for 2023, Kristina will need to wait until the beginning of 2024 to recontribute all or part of the $3,000 she withdrew (which will be added to her TFSA contribution room at the beginning of 2024). If she goes ahead and recontributes before that, she’ll have an excess amount in her TFSA. That means she’ll be charged a tax equal to one per cent of the highest excess TFSA amount for each month that excess remains in her TFSA

Mistakes to avoid   

Remember what we said about TFSA not being taxable? Well, that’s only if you play by the rules. For one thing, make sure you don’t exceed your contribution limit. Because over-contributions are indisputably, irrefutably taxed. In fact, you’ll be penalized at a rate of 1% of the excess amount for every month that an over-contribution sits in your TFSA account. 

Moreover, some taxpayers get confused – and then in trouble - with the rule on withdrawals. So be sure you understand how they work. To reiterate: a withdrawal will provide you with contribution room in the next year, not the current one. If you contributed your maximum $6,500 in 2023 and then withdrew $1,000, you have to wait until 2023 to get that contribution room back. If you mistakenly replaced that withdrawal in 2022, your error would be considered an over-contribution, subject to CRA penalties. 

For another, ensure your TFSA doesn’t include any prohibited investments – e.g., shares of a company in which you hold significant interest of over 10% - or non-qualified investments (which don’t have any tax benefits). If it does, you may be required to pay a tax of 50% of the value of the investment in question.  

A TFSA holder is also disallowed from carrying on a business, such as day trading, within their TFSA, with tax consequences a result of such activity. Finally, bear in mind that if you borrow money to invest in a TFSA, you are not allowed to write off the interest payments from your taxes. 

 

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