Canadian Tax-Free Savings Account (TFSA) Explained (2024)

Hands down my favourite INVESTMENT account. Notice my emphasis on “investment” here? That’s because I don’t want anyone to be fooled by the name of the account and use it as their savings account. In this article, I will help you understand what the TFSA is, contribution limits, and some of the mistakes to avoid so you can start growing your money tax-free.

Some topics we will go over are:

1. What is a TFSA?

2. Savings vs. Investing

3. Contribution Limits

4. Additional Information

What is a TFSA?

A tax-free savings account is a registered investment account that was introduced for us Canadians in 2009 with the purpose of allowing us to invest and save for our futures. Any Canadian resident 18 and over with a valid SIN qualifies for the account. In some provinces, the age to open your TFSA is 19, but your contribution limit starts when you turn 18. What makes the TFSA so powerful, and my favourite investment account, is that every single dollar you earn will be TAX FREE! In a typical unregistered account, you sell your investment, and you’re taxed on 50% of the capital gains at your marginal tax rate for your tax bracket. For example, say you buy TD Bank stocks and your investment rises by $10,000. Once you sell the stock, that will count as a taxable event, and you could be paying $1,000 or more in taxes. With the TFSA, you don’t need to worry about this, and you get to keep more of your money. Pretty powerful, hey?

Saving vs. Investing

When I opened my TFSA, I was fooled by the name and thought this was just a savings account. The Canadian Big 5 banks will typically give you an interest rate of 0.05% on the money you have stored with them unless they have a promotional deal going on, which is usually only for 3 months, and then you receive that low interest rate again.

Example of what TD Bank is offering as a “high interest savings account” as of May 20, 2024:

If you were to save $10,000 and receive interest from one of the big five banks, you would have earned about 50 cents by the end of the year. In 10 years, you’ll have earned $5.

If you were to invest $10,000 and receive a modest 7% return, you would earn $700 by the end of the year. In 10 years, you’ll have earned $9,671.51.

You’re probably wondering, “How am I supposed to get a 7% return?”. Well, if you look at the S&P 500, it has a historical average yearly return of 10.47% over the last 30 years. Now, this doesn’t mean 10.47% return each and every year, just over the long term.

S&P 500 Historical Return by Year:

Contribution Limits of the TFSA

The TFSA is a very powerful account, so there is a cap on how much you can deposit. If you were 18 years of age or older and a resident of Canada in 2009, your contribution room has started growing since then. If you were not quite 18 yet in 2009, your contribution room started growing when you turned 18.

Each year, you're given additional contribution room to invest in your account. Below, you'll see a table displaying each year's limit so far.

Don’t worry if you didn’t use your contribution limit this year or any of the previous years; all of the contribution room is carried forward, and you can start catching up right now. It is very important to not contribute more than the total cumulative limit to avoid penalties. If you overcontribute above your available limit, you'll be charged 1% of the excess amount in the account. To avoid overcontribution, it is recommended that you keep track of your deposits. You can use a very simple spreadsheet to keep track of your contributions, like me.

We have a lot of flexibility when it comes to the TFSA; we can withdraw money from the account whenever we want, tax-free, with no penalties. You do lose the contribution room, but unlike the RRSP, you regain that contribution room in the next calendar year. Keeping track of your deposits and remaining contribution limit also helps you make sure you're not withdrawing and recontributing in the same calendar year, resulting in an overcontribution penalty.

Below, you can use the TFSA contribution room calculator to find out your total and remaining limit. This calculator assumes you were a resident with a SIN at age 18.

If your investments grow, whether it is from capital gains or dividends, it does NOT affect your contribution room.
For example, if you have a $75,000 contribution room and you invest $10,000, your remaining contribution room is now $65,000. Say your investment grew by $2,000 and the total value of your portfolio is now $12,000; your remaining contribution room is still $65,000!

Additional Information About the TFSA

• You can't use this account for day trading; if you want to day trade, just open up a regular account.

• Even though this is a tax-free account, there is a 15% withholding tax when receiving foreign dividends.

• Avoid buying risky or speculative stocks within this account. If you're looking for the next Amazon and decide to invest $50,000 in a new startup that ends up going to $0, you will lose that contribution room forever.

• If you wish to change institutions, you can transfer the whole account over to the new bank or brokerage without it impacting your withdrawal or contribution limits. Do NOT withdraw the money and recontribute it; transfer the entire account yet. Say you have a TFSA with RBC and you want to move it to WealthSimple to start your investing journey. You can transfer the account directly from WealthSimple.

Interested in starting your investment journey?

Check out topics to learn about:

• Learn How to Save (2024)

• How to Start Investing