Key takeaways:

  • A TFSA is a registered account and the income you earn on it is completely tax-free.
  • TFSAs can hold a variety of types of accounts, including mutual funds, GICs and cash savings.
  • The government sets the maximum contribution room for your TFSA every year.
  • Unused contribution room rolls over into future years and accumulates.
  • There are no mandatory withdrawals from a TFSA and you can withdraw your money whenever you want.

Whether you have a Tax-Free Savings Account (TFSA) or have only heard about it in passing, you probably have some questions around how a TSFA works.

So, let’s talk investments. We’re here to make tax-free saving easier with our guide to everything you need to know about TFSAs.

What's a TFSA?

A Tax-Free Savings Account (TFSA) is a registered account where the income you earn is completely tax-free. You don’t even pay tax when you withdraw funds.

How does a TFSA work?

Just like when you invest in a Registered Retirement Savings Plan (RRSP), you can open a TFSA to invest in a variety of options — like savings accounts, GICs and mutual funds. You don't get a tax credit for investing, but once your funds are in the TFSA, any interest, dividends or capital gains can grow tax-free. 

Best of all, you have the freedom to withdraw funds any time you want. 

Any Canadian resident over the age of majority with a valid Social Insurance Number (SIN) can open a TFSA. Non-residents can't contribute to a TFSA, but can keep one that they already had (ex. if you opened a TFSA when you were a Canadian resident and then moved away and become a non-resident, you could keep the account open, but couldn’t contribute more money to it). Any contributions as non-resident attract penalties. 

Similar to an RRSP, the amount you can contribute varies year over year.

The government sets the maximum amount that you can contribute to a TFSA annually. 

Here’s a quick example of how this can work:

1. The Canadian government has set the maximum amount you can put into a TFSA in 2023 at $6,500.

2. You have $4,500 available that year to save and put this into your TFSA.

3. That leaves you with $2,000 remaining of your limit, which will then be added to future limits.

If the government raised the limit to $7,000 the year after, the surplus $2,000 from the previous year would be added. This would make your new limit $9,000. The TFSA annual limit is indexed to inflation and is rounded to the nearest $500. We will explain how you can check your limit later on.

How is it different from an RRSP?

If you’re wondering, how does a TFSA work compared to an RRSP, there are some key similarities and differences. Both are tax-advantaged savings plans.

With an RRSP, you defer paying taxes on the money you put in today and any investment income earned, until years later when you withdraw your money in retirement (you can learn more about RRSPs here). With an RRSP, you can withdraw money from it at any time, but it will be subject to withholding tax and will also be taxed as income.

With a TFSA, while you can use it to save towards retirement, you can also use it for many other goals because, unlike an RRSP, you’re free to withdraw at any time without penalties. Since you’ve already been taxed on the money you put into your TFSA, any income you earn from the investments within your TFSA is completely tax free, even when you withdraw from it.

Find out more about the differences between the TFSA and RRSP here.

How do you invest inside a TFSA or a RRSP? 

There's not much difference between how you open a non-registered account, like a savings account, and a registered one, like an RRSP or TFSA. You can open them with your provider either in person, through their online services or mobile app.

A great way to make sure you are growing your investments is to save automatically through pre-authorized contributions (PACs). This is where you save automatically, with an amount that you have chosen deducted from your savings or chequing account and deposited into your investment account.

What kinds of investments can I have in a TFSA?

You can have many different kinds of investments within TFSAs as well as RRSPs. This is useful for diversifying your portfolio. Options include: 

Cash Savings  you can store savings you have made in your account as cash. These can be regular amounts of money that you put away to save for the future.

Guaranteed Investment Certificates (GICs) – a low-risk investment where you deposit money for a set period of time and get a guaranteed rate of return on your investment.

Mutual funds they pool money in your portfolio from different investors. Depending on the fund’s goals, this money is then used to buy bonds, stocks or other securities.

How you invest depends on your goals and targets, and your risk tolerance.

How much can I contribute into a TFSA?

The amount you can put into your TFSA depends on your contribution room. The TFSA contribution room is the total of all of the following:

  • the TFSA dollar limit of the current year, which in 2023 is $6,500
  • any unused TFSA contribution room from previous years
  • any withdrawals made from the TFSA in the previous year

For example, if you have contribution room of $6,000, and you deposit $6,000 to a cash account in March, but you take it out in November, you cannot redeposit within the same calendar year. You must wait until next year for the $6,000 to be added back to your available contribution room.

The minimum age requirement to open a TFSA is 18. Although, in some provinces, this can be 19.

If you overcontribute, the Canada Revenue Agency (CRA) will charge a tax of 1% per month. The over contributions towards TFSA will be subject to a penalty of 1% per month. This is only on the over-contribution amount.

This will continue until the entire over-contribution amount is withdrawn, or the entire over-contribution amount is used by additions to their unused contribution room in the future.

You'll receive your contribution limit with your tax return, or you can contact the Canada Revenue Agency.

Is the TFSA good for people who are just starting out saving their money?

If you’re starting out saving, the Tax-Free Savings Account can be a great way to begin your investment journey. It’s handy if you don’t have a high taxable income, and also to high income earners who have reached their RRSP limit.

It’s also useful if you change your mind and want to do a withdrawal. That’s because you wouldn’t be penalized when you do this.

You can talk to your Scotia advisor about how the TFSA could work as part of your financial plan. 

What are the benefits of a TFSA?

There are many benefits of a TFSA, including:

  • You can take advantage of compound growth over the years with incremental investments.
  • Interest, dividends, and capital gains earned in a TFSA are tax-free.
  • If you withdraw money from your TFSA, you are able to return that money you’re your account as long as you have available contribution room.
  • You can give money to your spouse for them to contribute to their TFSA without any tax consequences.
  • Your TFSA contribution room isn’t income dependent. Contribution room is the same whatever your income is.
  • There are no mandatory withdrawals.

Why is a TFSA good for saving for retirement?

An RRSP and a TFSA can be used together if you’re using them to save for your retirement. A lot of people think of the TFSA as more of a short-term savings. But it’s also great for a flexible long-term savings plan that can help when you reach retirement age.

What happens to my TFSA if I die?

An RRSP and a TFSA can be used together if you’re using them to save for your retirement. A lot of people think of the TFSA as more of a short-term savings. But it’s also great for a flexible long-term savings plan that can help when you reach retirement age.Who do you want to have the money you have built up in your TFSA? For a spouse or common-law partner, you'll need to assign them as a successor holder to help them have a smooth transfer of your TSFA to theirs. The successor holder can make tax-free withdrawals from that account and put it into their own TFSA, depending on their own unused TFSA contribution room. 

If you designate your spouse or partner as a beneficiary of your TFSA, instead of as a successor holder, they have until Dec. 31 of the year following the year of death to contribute any payments received out of your TFSA (up to the date of death value) into their own TFSA without affecting their own unused TFSA contribution room. To complete this “exempt contribution,” they need to file CRA Form RC240 within 30 days after the contribution is made. 

You may also name your children, siblings, parents or friends as beneficiaries. They can contribute proceeds from your TFSA to their TFSA if they have enough contribution room. Your beneficiary should not have to pay tax on payments made out of the TFSA as long as the total payments do not exceed the fair market value of your TFSA at the date of death.

Talk to legal and tax experts about your situation to help guide you through this process.  

The bottom line

When TFSAs were introduced in 2009, they brought Canadians a whole new way of saving their money while allowing it to grow tax-free. TFSAs are a flexible option, letting you save for any length of time and invest according to your risk tolerance.

Talk to your Scotia advisor about if TFSAs are right for your investment plan. 

Ready to get your finances on track for your future? Come in and speak to a Scotia advisor today