TFSA – Tax Free Savings Account

I’ve had a few people ask about the Tax Free Savings Account, or TFSA. Some get the wrong idea because of the term “savings account”. While you can hold a savings account in the TFSA, you could also use it for stocks, mutual funds, bonds, GICs, and other investments.

In a lot of ways, the TFSA is similar to the RRSP. Both of these accounts allow you to grow your investments with a tax advantage. However, there is a diference in the way you fund the accounts, and when you actually end up paying taxes on the money. With the RRSP, you get a tax refund for money that you put into the plan and then pay tax on the money you withdraw during retirement. With a TFSA you do not get a refund when you put money in, but do not pay any tax when you withdraw money. You also don’t lose your contribution room when you withdraw from a TFSA; you can deposit that amount back in the next year, on top of the “regular” contribution.

Who Can Contribute to a TFSA?

Any Canadian resident with a Social Insurance Number, who is 18 or older can contribute to a TFSA, as long as he or she has reached the age of majority in his or her province. You don’t need earned income to make your contributions, and there are no income limits restricting you can contribute. The great thing about the TFSA is the contribution room. Not only can you withdraw the money and replace it at any time, but your contribution room also carries forward if you don’t contribute the maximum.

Man holds white egg with TFSA written on itTFSA contribution limits are indexed to inflation. For 2013, you are allowed to contribute up to $5,500. If you only contribute $4,500, you have $1,000 of contribution room. This means that you can contribute an extra $1,000 down the road. You could contribute $6,000 next year, and $6,000 the year after to “catch up.” Your contribution room starts when you are eligible for the TFSA, so if you didn’t contribute at all the first year you were able to, you have all of that money as contribution room.

Using Your TFSA to Best Effect

Many Canadians like the idea of using the TFSA as an emergency fund, and we do this with a small portion of my wife’s TFSA. They like the idea of a high yield savings account, or laddered GICs in the TFSA. However, this is not the most efficient use of a TFSA as a tax strategy. The rules of the TFSA mean that there is a lot of potential for tax savings down the road.

Since you do not pay taxes on your withdrawal, it is better to have high yielding investments in your TFSA. The expected larger gains will be tax free. It makes more sense to place lower yielding investments like bonds and GICs into RRSPs.

Divide up your long-term investment portfolio between your RRSP and your TFSA. Put the low-yielders, like GICs and bonds, into the RRSP. The earnings from these investments are generally fairly low, so paying taxes on them later wouldn’t cost you too much. Plus, you get the tax refund for your contributions now.

The TFSA is great as a long-term income tax shelter. If you were to purchase ETFs, stocks and REITs, and other income trusts in your TFSA, you can withdraw the earnings as continual tax-free income. Or you could let it build over time. Either way, these high-yielding investments have a greater chance of providing higher gains, so the tax-free withdrawal aspect is very attractive. Even if you have to pay taxes now, the prospect of avoiding what will, likely, be higher taxes later is a good one.

If you are pushing your contribution limits, though, it might not be best to include dividend paying stocks in your TFSA. They are already quite tax efficient. In fact, you might want to hold dividend paying stocks outside of both RRSPs and TFSAs.

Your best case is to max out both your RRSP and your TFSA if possible, focusing on allocating your assets in a way that provides maximum advantage.

Written by Tom Drake

Tom Drake is the owner and head writer of Canadian Finance Blog. While you’re here, consider signing up for the RSS feed or email subscription. Both deliver the latest articles directly to you! You can also follow me on Twitter for all the latest posts or to send me any comments or questions!

19 Responses to TFSA – Tax Free Savings Account

  1. Great article about TFSAs. I would like to know what the tax implications are for TFSAs when it comes to leaving a beneficiary or leaving the TFSA to you estate in the end?

  2. Smac20, if the beneficiary is a spouse or common-law partner, the TFSA remains intact and tax-exempt. If someone else is designated, the TFSA will no longer exist, but the portfolio’s growth will have been tax-free up to that point.

  3. Hi Tom does a TFSA have a limit to what it is not taxed at? Is it similar to the ISA in the UK that allows you to earn interest on up to £3600 a year tax free?

    • SE,
      There is the $5000 a year limit on what can be put in, but no limits on how much you can make without paying tax. Any interest, dividends, capital gains, etc. are tax free.

  4. Hi Tom
    Any thoughts on which financial instititution would be best for stocks TFSA? i see the banks on higher side of fee and questrade being cheap but at the same time, is quest trade reliable? why people still go to banks if questtrade is cheaper? any thoughts

    • Hey Nishant,

      Bottom line you need to remember about banks is that they are a business; and like any other business these days they are concerned with their bottom line. In my opinion most people go with banks because banks are familiar, well known, easy, and generally make you feel comfortable. Not because they are the best way to go. If you are comfortable being responsible for managing your stocks, etc then you could go with something like Questrade. Otherwise you can often get access to professionally managed investments through a financial adviser.

      – R

  5. see the banks on higher side of fee and questrade being cheap but at the same time, is quest trade reliable..Savings Guidance

  6. Hi there, Great article. Finally understand the difference between TFSA and RRSP.

    Probably you have answered this, but to clarify, if I put $5000 into a TFSA and invest in (non-dividend) stocks, and the return grows the $5000 to $5500 during the same year, is the $500 taxed because its over the $5000 limit? In other words, does the limitation only apply to the original investment?


    • I think the TFSA is an awesome way for retirement savings or an emergency fund, in the long run a much better tax advantage than your traditional RRSP.

      Any capital gains/dividends/interest payout from the investments is tax free and it does not count towards the yearly contribution.

      You can have multiple TFSA accounts, as long as the total money you transfer or contribute does not exceed the yearly maximum or carry-forward from previous years.

      My current strategy is a TFSA brokerage account set up with DRIP (dividend re-investment plan) with my bank, holding various ETF’s (Exchange Traded Funds). ETF’s are like mutual funds, but usually have much lower management fees than RRSP funds and they trade like stocks. With DRIP, the dividend payout will automatically purchase whole shares of the stock or ETF (providing the payout is at least the current value of the share/ETF price). There are no additional fees for this service. Some ETF’s pay monthly or once a quarter.

      The dividend payouts on most ETFs are usually more than those “high interest savings accounts” or GIC’s.

      A great website for research on some Canadian ETFs and model portfolios can be found on .

  7. Good job in clarifying! I’ve heard many people say that they haven’t invested in TFSA’s because “TFSA’s don’t earn much interest”. They think a TFSA is a specific investment! So not true.

  8. You stated: “Not only can you withdraw the money and replace it at any time,..”

    Be very careful here!!!

    As you know, each year there is a limit as to how much that one can contribute to a TFSA (currently it’s $5500). If you contribute the maximum in any given year, then withdraw any amount of money, and then decide to replace any of that withdrawn money “all in the same year” – then you are taxed big time by the Feds!!! You can only repay the withdrawn money in any year “following” the year of withdrawal.

    In the first year that the TFSA program was introduced to Canadians many people were not aware of this rule and were taxed. Often the financial institution handling one’s TFSA account does not clearly make this fact known to new TFSA enrollments. It was a learning curve for many folks.

    I routinely transfer investments (stocks, bonds, mutual fund shares, GICs, cash, whatever) from my taxable accounts over into my TFSA account, up to the yearly contribution limit, each January in order to tax shelter the interest gains that these investments produce. I highly recommend them. They are not just simply cash saving accounts and, unlike RRSPS, you can continue to contribute to them past age 71, without being required to start withdrawing any funds, unless you so desire.

  9. I like the idea of market linking both the RRSP and the TFSA to a low-fee Index Fund account like that of ING’s. The tax savings you get from contributing to the RRSP can also be allocated to the TFSA.

  10. For your interest, one way of looking at an RRSP is that it is equivalent to a leveraged TFSA, that is to say, equivalent to using your own money plus a government loan to invest in a TFSA. The government loan part of an RRSP is the so-called “tax refund.” The interest rate the government effectively charges on this tax refund loan depends on the difference between tax rates at contribution and withdrawal dates and the time that the money is invested in the RRSP.

  11. Does anyone know what the actualy penalties are for over-contributing to a TFSA? Let’s say I put in $6500 when I only had $5500 in contribution room for the year.
    Would the principle of the extra $1000 be hit by CRA, or would I simply be taxed on the interest the $1000 earns in the same way I’d be taxed on a non-TFSA investment?

    Nobody that I’ve spoken to seems to know. I even talked to my bank at one point and they didn’t want to tell me (I no longer to business with that bank for a multitude of reasons)

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