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You’ve likely heard of a Tax-Free Savings Account (TFSA), but maybe you’re not entirely sure how to incorporate it into your financial planning. No need to worry – we've got you covered.

A TFSA is a general-purpose savings account that allows you to make contributions each year and withdraw funds at any time. Unlike an RRSP, you can’t claim a tax deduction for contributions made to a TFSA, however, any funds withdrawn are added back to your contribution room the following year. Your TFSA contribution room carries over from year to year, so any unused contribution room is still available to you in the future.

Once you withdraw funds, there are no restrictions on how those funds must be used. Withdrawals can be made for personal reasons, investments, education, or any other purpose.

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It Should Really Be Called a “Tax-Free Investment Account”

The name “tax-free savings account” is a little misleading. You’re fully able to use a TFSA as a fancy savings account, but the true potential lies in investments.

Funds within a TFSA can be invested in a wide range of qualified investments including stocks, bonds, mutual funds, segregated fund contracts, and GICs. Once funds have been contributed to a TFSA, any growth or income earned on the underlying investments will not be taxed or impact your eligibility for federal income-tested benefits and credits.

This is HUGE. A TFSA is a hugely powerful financial tool that allows your investment growth to accumulate and be withdrawn tax-free. 

Should I Use My TFSA or RRSP?

There are a few considerations to take into account when deciding where to allot your funds.

The first is your tax rate. If your tax rate at the time of depositing funds is higher than your tax rate when those funds are withdrawn, an RRSP is likely the better choice to deliver a higher net rate of return. However, if the opposite is true (you have a lower tax rate now than when you plan to withdraw your money), a TFSA will provide a higher return.

Another factor is income-tested benefits and credits. If you’re in a low tax bracket, it’s generally good practice to place funds in a TFSA since there’s no impact on federal income-tested benefits such as Canada Child Benefit, Old Age Security, or Guaranteed Income Supplement when the money is withdrawn. 

Generally speaking, RRSPs are best used for retirement savings, while TFSAs can be used to effectively save for both retirement and other shorter-term purchases. Since TFSA withdrawals are added back to your available contribution room the following year, there’s very little downside to using the assets in a TFSA for mid- to large-sized purchases.

A strong approach is to use an RRSP with its higher tax-deductible limits for retirement savings, and a TFSA as a vehicle for supplementary savings. The right solution comes down to your individual goals and financial situation – discussing with an experienced financial advisor is encouraged to help you develop the best savings plan for you and your lifestyle.

Inflation can significantly impact your purchasing power and overall financial health

Find out how you can deal with inflation with our article: Managing Inflation: Guide to Protecting Your Finances

How Much Can I Contribute to a TFSA?

Your contribution room begins in the year you turned 18 and accumulates every year after that year (beginning in 2009 – if you were 18 or older in 2009, your contribution room accumulates from 2009 onwards).

You accumulate TFSA contribution room for each year, even if you don’t file an income tax and benefit return or open a TFSA. Any withdrawals made from your TFSA get added back as contribution room the year following the withdrawal. Any investment income earned by your TFSA investments does not affect your TFSA contribution room for current or future years.

Here are the yearly contribution limits from 2009 to 2024:

The Canadian Revenue Agency (CRA) tracks your TFSA contribution room for you, though it’s important to note that there can be a delay between the figure shown by the CRA and your actual contribution limit if you have made a deposit or withdrawal. You can access this information here.

What If I Over-Contribute?

The Income Tax Act imposes a penalty of 1% per month on the highest excess contribution amount at any point during the month. Any income which can be attributed to a deliberate overcontribution will be taxed at 100%.

Most often, overcontributions are made in error when a person makes a withdrawal from their TFSA and neglects to wait until the next year for that withdrawal amount to be re-added to their contribution room. 

The excess amount can be withdrawn to eliminate the penalty tax for subsequent months.

Reach the Full Potential of Your TFSA

A Tax-Free Savings Account is a valuable tool in a financial repertoire, but we understand that it can be difficult to grasp (and remember) all of the details and complexities. That’s why we’re here – to do it for you. 

Book a call with the experts at WealthTrack for an individualized savings plan and TFSA tracking, and for all of the TFSA- and finance-related information you could ever want or need. We’ve got you covered!

FAQs About Tax-Free Savings Accounts (TFSAs)

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