The Modest Wallet is a free digital publication delivering its readers simple personal finance solutions. We regularly partner with brands that have products and services that will help our readers. When you buy through links on our site, we may earn a small commission at no extra cost to you. How we make money.
TFSAs or Tax-Free Savings Accounts are still a relatively new concept, with the program being initially introduced in the 2008 budget of the Canadian government and only becoming open to consumers at the start of 2009. As a result, many Canadians are unaware or under-informed about TSFAs and what they have to offer, leading them to miss out on an accessible and simple way to make the most of their income and investments.
If you are among the reported 80% of Canadians who don’t know what a TFSA is, or how to get started with one of your own, this guide is for you. Here is everything you need to know about TFSAs:
What is a TFSA?
Despite the name, a tax-free savings account isn’t a savings account at all, but an investment account available to Canadian citizens through financial institutions and independent broker that is sponsored by the government. TFSAs were designed to help Canadians save money by holding investments including cash, stocks, bonds, dividends, guaranteed investment certificates, mutual funds, and even savings accounts. Anything put into the account is exempt from taxes, meaning the returns on investments you make within your TFSA are entirely your own, even when you withdraw the funds.
Who is eligible to open a TFSA?
To open a tax free savings account, you must be of the age of majority in the province or territory in which you reside and hold a valid social insurance number. In areas where the age of majority is over 18 years of age, individuals who are 18 years or older will accumulate additional contribution room towards their future TFSA for every year until they reach the age of majority in their jurisdiction.
Canadians who are classified as non-residents of Canada, meaning they regularly live outside of the country or spend less than 183 days per tax year within the country and maintain no residential ties such as a Canadian bank account, personal property, a home, a spouse, dependents, social ties, or medical insurance, are able to maintain their pre-existing TFSAs during their time as non-residents but will not receive additional contribution room during the time that they reside outside of the country.
How does a TFSA Work?
We’ve already touched on this a bit, but a tax-free savings account can be explained very simply. First, you’ll open an account, then you’ll make deposits into the account up to the maximum annual contribution limit in the form of cash deposits or various investments. From there, hopefully, you will see your money grow through returns.
You can withdraw money from your TFSA at any time, though you should be mindful of your contribution limits when choosing to make a withdrawal, as you may not have room to put the withdrawals back in without penalty if you change your mind.
Those are the basics you need to know about TFSAs and how they work, of course, there is more to know about them, but we will explain the intricacies later on.
What are the advantages of maintaining a TFSA?
The main benefit of having and maintaining a TFSA is that any growth or returns you earn on the funds and investments you contribute are completely tax-free, even if you choose to withdraw them. This makes a TFSA a must have for any investor, or really anyone looking to make the most of their money and take control of their personal finances.
Once you’ve made a deposit into your account, you can withdraw it at any time, for any reason, without penalty, so there is really no reason not to invest. You are even able to redeposit funds that you have withdrawn, though you will need to wait until the next year if the deposit would exceed your annual contribution limits in order to avoid being hit with a penalty on the amount in excess.
If you are a retiree, TSFAs have an additional benefit. Any money you withdraw from your account is not considered income, which means it will not impact any benefits you may be receiving such as your Canadian Pension Plan and Old Age Security. If you're not retired yet, this is still a great thing to keep in mind when considering or maintaining your TFSA, you’ll never regret putting more away to provide security and comfort when you are no longer able to work.
If you are hesitant to invest in your tax-free savings account as part of your retirement plan, don’t be! If something should happen and you pass away before you are able to use the full amount you have contributed, there is a program in place to ensure the remainder of your funds goes to your named beneficiary, successor, or estate.
Most commonly your successor will need to be your spouse or common-law partner, but you can appoint anyone you wish as a beneficiary. If you appoint a minor as your beneficiary, you will also need to select a trustee to manage the account until they reach the age of majority.
How to open your own TFSA
Opening a tax free savings account of your very own is a simple and relatively pain-free process. If you meet all of the necessary requirements, you will need to start by contacting your financial institution or credit union, we recommend using Questrade, Tangerine, or Wealthsimple to set up your tax-free savings account. You will then need to provide whichever service provider you have selected with your name, date of birth, and social insurance number so that they can register your qualifying arrangement for a TFSA. You may need to provide additional supporting documents to open your account, but after that, you are all set!
Types of TFSAs
There are four types of tax-free savings accounts available to you: an annuity contract TFSA, an arrangement in trust TFSA, a deposit TFSA, and a self-directed TFSA.
The first three types fall under the category of a “Regular TFSA”, meaning these are accounts opened through a financial or investment institution. TFSAs that are opened through an institution are often subject to restrictions on the types of investments you can hold within them, you will generally be limited to the investments types offered, issued, and managed by the institution you opened your account with. This isn’t necessarily a bad thing, but it is something to consider when you are looking to open your account.
The self-directed type of TFSA is opened through a broker or investment professional. This type of TFSA allows you to contribute through a much wider array of qualified investments, regardless of provider.
You don’t need to choose between a regular and a self-directed TFSA though, anyone who meets the basic requirements for opening a TFSA is eligible to open multiple TFSA accounts without penalty, so why not dive in and explore your options?
How much can you contribute to your TFSA?
Since the launch of the TFSA program in 2009, contribution allowances have varied year to year. The contribution limit for 2019 AND 2020 is set at $6000, up from $5,500 between 2016 and 2018. In 2015 the contribution limit for TFSAs reached a record high of $10,000, nearly doubling the $5,500 limit from 2013 and 2014. In the first four years of the program, 2009 to 2012, the contribution limit was set at $6000.
Any unused contribution room will carry over for one year, for example, if you were to open a TFSA in 2019 without having contributed to one previously, your contribution limit for the year would include the $5,500 from 2018 and the limit of $6000 for 2019, for a total contribution limit of $11,500 for the year. Withdrawals made will also add to the contribution limit of the next year, up to the maximum of the previous years' contribution limit.
What kind of investments can you hold in your TFSA?
As mentioned earlier, the type of investments you can hold in your TFSA vary based on the kind of account you choose as well as the financial institution you open it with, but generally speaking, your TFSA can hold any investments that would be allowed in a registered retirement savings plan. These investments include but are not limited to bonds, cash, guaranteed investment certificates, foreign funds, mutual funds, listed securities, and transfers from your RRSP.
Self-directed TFSAs that are handled through a broker are much less limited and allow for a wider array of investments including but not limited to annuity contracts, debt obligations, eligible corporate shares, exchange-traded funds, instalment receipts, mortgages, partnership and royalty units.
For more information on what investments your specific TFSA can hold, speak to your financial institution or investment broker.
Can you withdraw from your TFSA?
Yes, you can withdraw funds from your TFSA at any time, typically without restriction, however, certain investment types come with their own product related restrictions, like investment maturity dates.
Any money withdrawn from your TSFA can be redeposited into your account the following year without affecting your contribution limits.
What happens if you over contribute to your TFSA?
When you over contribute to your TFSA, purposely or by accident, the Canada Revenue Agency imposes a tax of 1% for every month, full or partial, that your account remains in excess. To remedy the issue, you will need to withdraw the amount in access, or in some cases, you can wait until it is covered by spare contribution room within your TFSA.
Our top 3 recommendations for your TFSA
With all of this new information in mind, you are probably eager to start investing in a TFSA of your very own. Here are our top three recommendations for opening and managing a tax-free savings account:
Wealthsimple is a great place to open or transfer an existing TFSA, offering accounts with a low fee of only 0.50% on top of the cost of existing ETFs which tend to average 0.20%, an approximate total of 0.70%, well below the typical annual rate of 2%. Wealthsimple also offers a free TFSA tracking tool which helps you navigate the ins and outs of your account without having to keep up to date with the latest CRA rules and contribution maximums.
The company also utilizes award-winning strategies and industry-leading technologies to help you craft the perfect customized investment portfolio, offering you the maximum returns without the risk.
If that wasn’t enough to catch your interest, Wealthsimple offers members access to their team of highly qualified portfolio managers any time you need it.
Tangerine is another strong contender for your TFSA, offering tax-free savings accounts with a high-interest rate. When you open a TFSA with tangerine, you will earn 2.75% interest on your contributions for the first six months, and 0.70% forever after. TFSAs through Tangerine has no minimum account balances, which can be very helpful when you are first starting out, as well as no annual fees. If you are already a customer of the bank, you can even set up automatic contributions to your account directly from your chequing account.
Tangerine also provides a tool to help you track your progress to help you achieve your investment and contribution goals.
Last but certainly not least is Questrade. Questrade is the fastest growing online broker in Canada and offers TFSA accounts with no minimum required, no annual fees, and no limits on how many accounts you can hold with them. When you are ready to start adding investments into your TSFA, they offer a very accessible $1000 minimum, and some of the lowest available fees on trades, starting at $4.95 per trade.
You really can’t go wrong with any of these service providers, they are all high-quality service providers that offer you a completely safe, secure, and easy to use platform to manage your TFSA and investments, and unlike opening a TFSA with a regular financial institution, they offer you much more flexibility and access to expert help and resources.
Download our FREE
“Stock Market Playbook” eBook
Learn everything you need to know to invest your first $500 in the stock market and become a do it yourself investor