Tax-Free Savings Account (TFSA)

What is a TFSA?

A Tax-Free Savings Account (TFSA) is a Canadian registered account that lets residents aged 18 or older contribute after‑tax money, invest it, and earn tax‑free investment income. Contributions are not tax‑deductible, but interest, dividends, and capital gains earned inside the account — and any withdrawals — are tax free.

Although called a “savings” account, a TFSA can hold cash or a wide range of investments (see permitted investments below) and can be used for any financial goal: emergency savings, a car, a home down payment, education, or retirement.

Key features

• Contributions are made with after‑tax dollars (not tax deductible).
• Investment growth and withdrawals are tax free.
• No requirement to have earned income to contribute.
• No mandatory withdrawals.
• Unused contribution room carries forward indefinitely.
• Withdrawn amounts are added back to contribution room at the start of the following year.

How contribution room works

• Contribution room accumulates for each year since 2009 for which you were age 18 or older and a Canadian resident, even if you did not open a TFSA.
• Unused room carries forward indefinitely.
• Withdrawals create additional contribution room, but that room is only available beginning the next calendar year (not the same year as the withdrawal).
• Earnings and fluctuations in account value do not affect contribution room.
• The annual TFSA dollar limit is indexed to inflation and rounded to the nearest $500.

Typical historical annual limits:
– 2009–2012: $5,000
– 2013–2014: $5,500
– 2015: $10,000
– 2016–2018: $5,500
– 2019–2022: $6,000

(Check current government guidance for the most recent annual limit.)

Over‑contributions and penalties

• Contributing more than your available TFSA room is considered an over‑contribution.
• The Canada Revenue Agency (CRA) charges a penalty tax of 1% per month on the excess amount until it is withdrawn or absorbed by new contribution room.
• Contributions made while you are a non‑resident of Canada are subject to a 1% per month tax while you remain non‑resident.
• Other taxable events (e.g., prohibited or non‑qualified investments held within the TFSA) can also trigger taxes and reporting obligations.

Withdrawals

• Withdrawals are tax free and may be made at any time without penalty.
• Withdrawn amounts are added back to your TFSA contribution room at the beginning of the following year.
• Making a withdrawal in the same year and then re‑contributing that withdrawn amount can cause over‑contribution unless you have sufficient unused room.

Permitted investments

Common investments permitted in a TFSA include:
– Cash
– Guaranteed Investment Certificates (GICs)
– Mutual funds
– Bonds
– Securities listed on a designated stock exchange
– Certain shares of small business corporations

Confirm with your financial institution or advisor that a specific investment is eligible before buying it inside a TFSA.

How to open a TFSA

• Eligibility: Canadian resident, age 18 or older, and a valid Social Insurance Number.
• You can open multiple TFSAs, but total contributions across all accounts must not exceed your available TFSA room.
• Steps: choose a financial institution and TFSA type (deposit account, self‑directed, trust arrangement, etc.), apply with SIN and ID, fund the account. The institution will register the TFSA as a qualifying arrangement with the CRA.

TFSA vs RRSP (key differences)

• Purpose: RRSPs are targeted at retirement savings; TFSAs can be used for any goal.
• Tax treatment of contributions: RRSP contributions are tax‑deductible; TFSA contributions are not.
• Tax treatment of withdrawals: RRSP withdrawals are taxable as income; TFSA withdrawals are tax free.
• Impact on benefits: TFSA income and withdrawals generally do not affect income-tested government benefits.

Example: If $6,000 earns 7% in a TFSA, the full $6,420 can be withdrawn tax free. In a regular taxable account, the earnings portion would be subject to tax.

Pros and cons

Pros
– Tax‑free growth and tax‑free withdrawals.
– Flexible use (no purpose restrictions).
– Unused contribution room carries forward.
– Withdrawals can be made any time without penalty.
– Withdrawn amounts are added back to contribution room the following year.
– Income earned in a TFSA doesn’t affect most government benefits.

Cons
– Contributions are not tax deductible.
– Over‑contributions incur a monthly penalty tax.
– Contributions made while a non‑resident are subject to tax.
– TFSA assets are generally not protected from creditors.
– Certain non‑qualified or prohibited investments can trigger taxes.

Practical tips

• Track your contribution room carefully (CRA provides information via My Account). Remember that multiple accounts don’t increase your room.
• Avoid re‑contributing withdrawn amounts in the same year unless you have sufficient unused room, to prevent over‑contribution penalties.
• Use a TFSA for shorter‑term goals, emergency funds, or long‑term tax‑efficient investing — its flexibility makes it useful alongside an RRSP.

Bottom line

A TFSA is a versatile, tax‑efficient savings and investment vehicle for Canadian residents. It allows after‑tax contributions, tax‑free growth, and tax‑free withdrawals for any purpose. Understanding contribution room rules, withdrawal timing, and eligible investments will help you use the account effectively while avoiding penalties.