What is a Tax Free Savings Account?
What exactly is the Canadian Tax Free Savings Account (TFSA)? How can I make use of this account and build wealth? Today I will answer these questions, cover the investible options out there, and explore some ideas of how best to take advantage of this powerful wealth building tool for Canadians.
TFSA Quick Overview
Briefly speaking, a tax free savings account is an investment account available to Canadians that provides powerful tax benefits for saving and investing. Briefly speaking, all interest, capital gains, and dividends are not taxed. On top of this, withdrawals carry no tax implications, so they can be pulled out at any time tax free. However, contributions are not deductible for income tax purposes and therefore made with after-tax income.
Tax Free Savings Account vs High Interest Savings Account?
A very common misconception with TFSAs is that they are simply a savings account. In other words, many savers and investors look at these as simply high interest savings accounts that are not taxed by the government. While this is possible, this only scratches the surface of what can be done within a tax free savings account.
Try to see a TFSA as a tax sheltered investment container that can hold different types of investments which will not taxed. So in this way, they are more like an investment account with tax benefits, and not a savings account.
Types of Eligible Investments
Investment Type | Comment |
Cash Savings Account | Lowest returns, with lowest risk. Very liquid |
GICs | Higher returns than cash Usually requires a term deposit so it is not as liquid as cash. |
Bonds | Lower returns than stocks Principle can be put at risk if traded on secondary market |
Stocks | Higher returns with higher risk Stock must be listed on one of 46 recognized exchange to be eligible. (TSX, TSX-V, NASDAQ, NYSE, LSE, ASX, are all good) OTC stocks are NOT eligible |
ETFs | Funds that trade like stocks Carry lower fees than mutual funds Generally higher returns than comparable mutual funds ETF must be listed on one of the recognized exchanges to be eligible |
Mutual Funds | Higher management fees than ETFs, Classic investment vehicle with proven track record |
Options | These can be used to hedge stock exposure or leveraged returns. Not suitable for novice investors Only certain option trades are TFSA eligible |
ETFs Open the World and Asset Class
How Do TFSAs Work?
The qualifications for opening and contributing to a TFSA is quite simple. Any resident who is 18 years of age or older and who has a valid social insurance number (SIN) is eligible to open a TFSA. If you happen to be a non-resident with a valid SIN, then you can still open a TFSA but you are subject to a 1% tax for each month the contribution stays in the account. For more information for qualifications, visit the Canadian government website.
Contributions
Because of the tax advantages available to us through a tax free savings account, there are limits on how much we can put into this account each year. Roughly speaking, each year we are allowed to contribute $6,000. Every so often the limit will be raised by $500 to account for inflation. Also note that any unused portion of your limit rolls forward each year.
Year | Contribution Limit |
2009 | $5,000 |
2010 | $5,000 |
2011 | $5,000 |
2012 | $5,000 |
2013 | $5,500 |
2014 | $5,500 |
2015 | $10,000 |
2016 | $5,500 |
2017 | $5,500 |
2018 | $5,500 |
2019 | $6,000 |
2020 | $6,000 |
2021 | $6,000 |
Grand Total | $75,500 |
Over Contributions
If you happen to over contribute to your TFSA and exceed the limit there is a penalty. The excess amount you contribute is subject to a 1% per month penalty tax. So if you over contribute by $2,000 in a given year, you would be paying a penalty of $20 a month as long as the excess amount is still in your account. So just make sure you’re under the limit each year.
Withdrawals
Now that we’ve got the hard stuff out of the way, withdrawals are much simpler to understand. Simply take the money out any time you need it without any tax implications. On top of this, you don’t even need to declare the income or the tax event. However, your financial institution will report the withdrawal to the CRA.
While on the topic of reporting the withdrawal, it is actually in your benefit because any withdrawal can be put back at anytime later. This means if you take out $10,000 to fund a purchase or emergency, then next year you can put back this $10,000 plus the new contribution room for the new year. So the formula for contribution limit is actually last year’s withdrawals plus this year’s new limit
TFSA vs RRSP
So if both a TFSA and an RRSP are tax sheltered investment schemes, what’s the difference between them? Well, before we expose the differences, we first must realize that the taxation within each structure is largely the same, as both shelter returns from taxation.
All of the differences between the two center around contributions and withdrawals. Unlike with an RRSP, you receive no tax breaks or income tax deduction when you contribute to a TFSA. This means you contribute using after-tax money to this account.
On the other hand, withdrawals from a tax free savings account will not be taxed, nor will they increase your taxable income reported for the year. This is in contrast to the RRSP where withdrawals are taxed and reported as normal income even if the returns were capital gains in nature.
Year | TFSA | RRSP |
Primary Purpose | Tax free savings for any purpose (incl. retirement) | Saving for retirement |
Contributions | Not tax deductible and made with after tax income | Tax deductible |
Withdrawals | Not taxed and does not increase taxable income | Counted as earned income |
Returns Taxation | Sheltered and not taxed | Sheltered and not taxed |
Contribution Limits | $6000 a year | Capped at 18% of last year’s earned income |
Making The Most of Your Tax Free Savings Account
Maximize Contributions
Tax Shelter Advantage
- Instead of paying down your mortgage, put the money here. The tax savings are the same plus the returns can be higher for the TFSA.
- Create a tax free passive income stream. Remember, all of your withdrawals are tax free. So this means you can configure a robo-advisor to send you a monthly cash flow from your TFSA. Or you can manually withdraw the dividends and interest from your account.
- Invest your tax inefficient investments here so they are not taxed. If you have a brokerage account and you’re investing there, consider putting your interest bearing investments in your TFSA for better after tax returns.
- Your TFSA account can be used for buying and selling stocks, so you can trade without tax consequence or having to compile complicated tax reporting documents at the end of the year. This can not only save you tax, but also the headache of reporting every buy and sell.
- ** Be careful not to day trade, as this can attract attention and be classified as a business.
- Use your TFSA as an extension of your RRSP once you hit your contribution limit there
Open a Tax Free Savings Account
Opening a TFSA is very simple to do and can be done with any of the major banks in Canada. They each offer a comprehensive array of solutions, portfolios, and even have self-directed options.
Big Bank Options
Investment Product | BMO | CIBC | Scotia | TD | RY |
Savings Accounts | Yes | Yes | Yes | Yes | Yes |
GICs | Yes | Yes | Yes | Yes | Yes |
Bonds | Yes | Yes | Yes | Yes | Yes |
Stocks | Only through Self Directed | Only through Self Directed | Only through Self Directed | Only through Self Directed | Only through Self Directed |
Mutual Funds | Yes | Yes | Yes | Yes | Yes |
ETFs | Yes | Yes | Yes | Yes | Yes |
Portfolio Solutions | BMO Ascent Portfolios
BMO Select Trust Portfolios | CIBC Smart Investment Solutions
CIBC Passive Portfolios | DynamicEdge Portfolios
Scotia Selected Portfolios
Scotia Aria Portfolios | TD Comfort Portfolios | RBC Select Portfolios
RBC Select Choices Portfolios |
Self Directed | Yes, BMO InvestorLine | Yes, CIBC Investor’s Edge | Yes, Scotia iTrade | Yes, TD Direct Investing | Yes, RBC Direct Investing |
Online Only Bank Options
Some readers would be interested in lowering their transaction and management fees. To this end, there are some online only banks that offer some great options too.
Investment Product | WealthSimple | Questrade | Tangerine |
Savings Accounts | No | No | Yes |
GICs | No | Yes | Yes |
Bonds | No | Yes | Yes |
Stocks | Yes, WealthTrade | Yes | No |
Mutual Funds | No | Yes | Yes |
ETFs | No | Yes | Yes |
Portfolio Solutions | Robo-Advisor ETF Solution – Conservative – Balanced – Growth
Socially Responsible Portfolios
Halal Investing Solution
| QuestWealth Portfolios – Conservative – Income – Balanced – Growth – Aggressive
| – Dividend Portfolio
– Equity Growth Portfolio
– Balanced ETF Portfolio
– Balanced Growth ETF Portfolio
– Equity Growth ETF Portfolio |
Self Directed | Yes, WealthTrade | Yes | No |
WealthSimple
WealthSimple is a terrific robo-advisor platform that takes care of all the investing transactions for you and tailor-fits a low cost ETF portfolio to your risk tolerance and investment timeline. On top of this, they also offer a commission free trading platform if you’re wanting to go it alone.
Questrade
First and foremost, Questrade is one of the best trading platforms available to Canadians and you’re able to buy ETF’s commission free. This means you can easily buy and hold all-in-one ETF portfolios offered by Vanguard or iShares.
Additionally, Questrade also offers their robo-advisor platform called QuestWealth. Much like WealthSimple, they will handle all the transactions and portfolio balancing for you to ensure you’re always on the right investing path.
Tangerine
Their primary focus is offering a high interest savings account and access to GIC’s. They are broadening their product offering into ETFs and portfolio solutions
Personal Recommendation for a TFSA
I really prize simplicity and low-fees when it comes to my investing. I personally love to set it, forget it, move on with life, and focus on generating more income elsewhere so I can further invest this.
For this reason, I’ve been using WealthSimple Invest for my tax free savings account. I make regular contributions and let them manage the trades, rebalancing, and dividend reinvestment. There are no transaction fees for the trades, however they do charge a small 0.50% management fee for this service.
If you sign up with WealthSimple, use my referral link so we both get a $50 bonus.
Conclusion: The Tax Free Savings Account is a Win
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