A Tax-Free Savings Account (TFSA) is an excellent place for your money – however, it’s actually not a savings account at all!
Find out what it is and whether you should open one in this article.
What is a Tax-Free Savings Account (TFSA)?
The tax-free savings account was introduced in 2008 by the Canadian government to encourage people from Canada to save money.
The first thing to clarify about this account is that, despite its name, it isn’t a savings bank account at all!
Interestingly, it was created specifically to help Canadians grow their savings, both long-term and short-term – but that doesn’t make it a savings account.
Now you might be thinking: “If not a savings account, then what is a TFSA?”
A TFSA is an umbrella investment account that can hold a mix of investments all at the same time. You can choose whichever asset you want to include in your TFSA.
Some eligible investment vehicles, for example, are:
- Mutual Funds
- Guaranteed Investment Certificates (GICs)
- Exchange-Traded Funds (ETFs)
TFSA PROs: Tax Benefits
All of the investment savings in the TFSA are tax-sheltered, so they will grow tax-free as long as you keep them in the account.
That’s why TFSAs fall into the category of tax-advantaged accounts.
You can withdraw money from a TFSA as many times as you want and penalty-free. Since you already paid tax on the money you put in the TFSA, there’s no tax to pay when you make a withdrawal.
These tax exemptions are in place to encourage Canadians to save responsibly for large purchases, such as buying a home or building a retirement plan.
TFSA CONs (potentially): Over-Contribution, Money Loss
Opening a TFSA is a great way of growing your savings, but if you are not careful about respecting its rules, it can work against you.
One important rule to keep in mind is to always stay within the TFSA’s yearly contribution limit.
If you over-contribute by mistake, you’ll have to pay a fine of 1% per month on the excess contributions until you don’t take it out, which isn’t cheap at all!
Also, remember never to day-trade stocks in your TFSA, or the Canadian tax authorities will penalize you.
Last but not least, the investments held in the TFSA, like any other investment, can also bring you a loss.
Any loss incurred with a TFSA investment will not be regarded as a withdrawal (because it isn’t one), so that amount won’t influence your contribution room for that year.
Who Can Open a TFSA?
To open a tax-free savings account, you must be a Canadian resident. That’s a mandatory requirement, with no way around it.
In addition, you must have reached the age of maturity and have a Canadian Social Insurance Number (SIN), which is just like the American SSN.
Provided you reside in Canada and possess all of the other prerequisites, you will probably get most benefits from opening a tax-free savings account if:
- You want to save a large amount of money to buy a house, a car, and so on, and you want to be able to grow your savings tax-free to do so.
- You want to be able to access your money quickly. Like we’ve mentioned, there is no limit of times you can withdraw money from your TFSA, unlike what happens with RRSPs.
- You’ve already maximized contributions to your Registered Retirement Savings Plan, so you’re looking for another way to grow your savings by investing in a tax-free account.
- You’re worried that some forms of investments could prevent you from accessing income-related benefits (like tax credits) that don’t apply to high-income earners.
Rest assured that TFSAs have no impact on these.
How To Open a TFSA
Opening a TFSA requires a straightforward process. The only requirements are for you to be Canadian, 18 or older, and have a valid Social Insurance Number (SIN).
First of all, you’ll need to contact a financial institution of your choice and tell them you’d like to open a TFSA account.
Then, you’ll need to give that financial institution your personal information, including additional documents that prove your identity, residence, and date of birth.
If everything provided is correct and you are not missing any information, it’s that simple. No further steps are required!
Since many banks, credit unions, and investment companies offer TFSAs accounts, I’d suggest you have a look at their website to find more information.
You’ll be looking for low fees, highly-rated customer service (in person, online, and by phone), and no minimum investments.
You should be able to open a TFSA both online or in-person, depending on your preference and financial needs.
TFSA Contribution Room
A specific TFSA contribution room limit you implicitly agree to respect while signing up for the account.
If you ever go over the pre-established amount, you’ll lose 1% of the amount, which exceeds the limit for as long as you leave that amount in the account.
Unfortunately, exceeding the limit and over-contributing can be easy since you can open as many TFSAs as you want in your name.
However, they will still be regarded as one for contribution room purposes (in other words, they will all count towards the same limit).
It’s better for you and especially your savings if you make a conscious effort to stay under the contribution limit.
What Is The TFSA Contribution Limit Per Year?
The Canada Revenue Agency (CRA) will update their contribution limits webpage as soon as they have decided on a new limit for the year.
Make sure you stay up to date and check that page at least once a year.
As an example, the CRA set the limit for 2021 at $6,000, plus the total lifetime limit in 2021 is $75,000.
If you are just starting in 2021, know that once you have contributed $6,000, you’d better stop to avoid any problems.
On the other hand, if you’ve contributed in the past, calculate how much you can still contribute before reaching your maximum lifetime limit.
Make sure you don’t contribute one penny more than that!
Types of Investments
TFSAs are like baskets that you can fill with any qualified investment you prefer.
There are stocks, bonds, mutual funds, ETFs, GICs, real estate, and anything else you might consider investing in to grow your money. Options are virtually unlimited!
Which one is the best option for you will depend on your savings goals. If you were looking to save short-term, you might want to opt for a certain kind of investment, a different one than if you were to save long-term, for example.
Often, it’s best to have a mix of different investments in your TFSA instead of choosing one type of investment over another.
It’s worth creating a strategy after carefully considering your goals, the level of risk you are comfortable with, eventual taxes, liabilities, and other assets you have available.
If you’re not sure how to maximize your gains while minimizing risks, it’s worth consulting an advisor before making your decision.
TFSA vs. RRSP
The RRSP (Registered Retirement Savings Plan) introduced in 1957 has been the best personal savings vehicle offered by the Canadian government until 2008 when the TFSA (Tax-Free Savings Account) was introduced.
They are both great ways to grow your savings tax-free. Still, they have a series of significant differences that we are going to look into, divided into categories to be clearer:
- TFSA: Contribution limits for a TFSA are the same for everyone regardless of the income earned. As mentioned earlier, for 2021, the annual contribution limit is $6,000, while the comprehensive lifetime limit for 2021 is $75,000.
- RRSP: RRSP contribution limits are income-related. They are based on how much income you have earned the previous year, up until you reach a maximum amount, which in 2021 would be $27.830.
- TFSA: All withdrawals are tax-free, and you can withdraw without incurring any tax penalty as many times as you’d like from your TFSA. You’ll need to wait to invest more money in the account until the following year or in future years to avoid over-contribution fees.
- RRSP: Withdrawals are taxed using the applicable marginal tax rate and can’t be re-contributed next year.
- TFSA: Your contributions to the TFSA account won’t reduce taxable income since they are not tax-deductible. The investment income, capital gains, and tax returns earned with your TFSA are all tax-free.
- RRSP: The opposite happens with RRSP’s contributions. They will reduce taxable income because they are, in fact, tax-deductible. The income and tax returns earned with your RRSP are tax-sheltered only until withdrawn.
Choosing between a TFSA or RRSP can ultimately depend on your preference between getting an immediate tax break with an RRSP vs. a large tax break in the future with a TFSA.
Another factor you might want to consider is that accessing your money before retirement will also be much easier with a TFSA.
Remember that you don’t have to choose. You can, and if you already have enough money saved up, you probably should have both.
Naming a TFSA Beneficiary
So, what happens to your TFSA after you die?
Nobody wants to think that far, but it would be best to do so, especially if you’re going to name a beneficiary for your TFSA account after you pass away.
Spouses, children, common-law partners, and whoever else inherits the account holder’s fortune will be assigned the TFSA.
They’ll become successor holders, provided that the account holder hasn’t named a different designated TFSA beneficiary beforehand.
It’s essential to know that any income the new beneficiary earns on the deceased holder’s account will continue to be tax-free.
Be careful in case the original TFSA holder had exceeded the maximum contributions because, in that case, the exceeding contributions will be automatically counted towards your limit as a beneficiary.
If you still have unused contribution room, you’ll be fine. Otherwise, this will put you in a bad position exposing you to the risk of paying a 1% monthly tax over the amount over the limit.
5 Best TFSA Rates in Canada
You can open TFSA at brick and mortar or online banks, but the latter usually offer better interest rates.
1. EQ Bank
One of the best rates currently available is the one offered by EQ Bank. This bank has options for you to invest your savings both in TFSAs, RRSPs, or high-yield GICs at an impressive rate of 2.30%.
This account also has no minimum investments, no monthly maintenance fees and is eligible for CDIC insurance up to $100,000.
Tangerine is an online-only bank that is extremely popular among Canadians.
It offers a very high savings rate of 2.10%. Unfortunately, this rate is introductory, so it will only last for five months from when you open your new account.
After this trial period is over, the rate lowers significantly and becomes 0.10%.
Tangerine deposit accounts also have no fees, no minimum balance, and are CDIC insured.
3. Canadian Tire Bank
The TFSA savings rate offered by Canadian Tire Bank is 1.80%, which is a pretty good rate.
This account also has no monthly service fees, no minimum balance required, and no lock-in periods.
In addition, deposit accounts are eligible for CDIC insurance.
4. Motive Financial
Motive Financial Bank is a division of Canadian Western Bank. Its Tax-Free Savings Account comes with a 1.25% interest rate, and it’s CDIC insured.
Motive Financial asks for no minimums or monthly fees and allows free unlimited transactions.
Learn More at MotiveFinancial.com
5. Alterna Bank
Alterna Savings and Credit Union own Alterna digital bank.
Alterna offers a TFSA e-savings account at a rate of 1.20%.
Alterna Bank requires no minimum balances, minimum investments, or fees to open and keep your TFSA.
In addition, unlimited transactions are included in the offer, and deposits are CDIC insured.
Can I have a joint TFSA?
No, just like with other registered accounts, such as RRSPs, it isn’t possible to hold a joint TFSA.
You can, though, contribute to your spouse’s TFSA without having your own contribution limit affected.
Can I open more than one TFSA?
Yes, you can open as many TFSAs as you’d like as a single individual.
Keep in mind that all of these accounts will contribute towards that year’s contribution limit. So, if you have more than one TFSA, you should be extra careful about not over-contributing.
What other forms of savings should I consider?
It’s always a good idea to diversify your investments.
If you are all set with retirement savings and have already opened and maximized your TFSA, you have several options.
Opening a high-yield savings account, an interest-bearing checking account, a personal investing account, or a substantial emergency fund are great starting points towards financial health.
An RESP, which stands for Registered Education Savings Plan, it’s a great option to start building up savings to benefit your children in the future.
These are only some of the many ways you have to build up your savings and invest in your future.
For more information, visit financial institutions’ websites and talk to a representative. They’ll be able to help you and take care of your specific requirements.
Does TFSA have taxes?
A TFSA is technically a tax-free account. After all, its full name is Tax-Free Savings Account! Nonetheless, there are some occasions when it could be taxed.
There are two instances where you will be most certainly taxed, and they are:
- If you exceed the annual contribution limit or the lifetime total contribution limit for a given year.
- If you qualify as a non-resident of Canada for some time and contribute to the TFSA during that time.
In the first scenario, you will have to pay a tax of 1% on any amount that exceeds the contribution limit every month for the whole year. That’s until you withdraw the necessary amount and are within the limit again.
In the second scenario, the tax will still be a monthly 1% for that year. You will qualify as a non-resident of Canada if you live for most of the tax year in another country.
Can I lose money with a TFSA?
Yes, as with any other form of investment, losing money is a possibility. Since the TFSA holds several different investment options, the risk depends on your investment decision.
A riskier investment will have both a potential higher return and a potential higher loss, as with many things in life.