Tax Free Savings Account

Posted by
on 07-07-2022

1. What is the TFSA?

It is no secret that investment income earned in Canada is taxed at a high rate. Registered retirement plans offer investors an option to defer some of their tax liabilities. The most effective way to shelter investment income from tax is by investing in a Tax-Free Savings Account. A TFSA is an investment vehicle in which the income earned from the investments in the account and the withdrawals from the account are not taxed (hence the name tax-free). Individuals can contribute and withdraw funds without paying taxes for any of the transactions. All interest, dividends, and capital gains generated inside a TFSA are tax-free. All Canadian residents of at least 18 years of age with a valid Social Insurance Number (SIN) can contribute to a TFSA up to a certain limit, which will be discussed below. Note that non-residents are also allowed to contribute to a TFSA, but they will be subject to a 1% tax for each month the money stays in the TFSA. Also, note that in certain provinces and territories the age of majority is 19 and, in that case, investors can contribute only if they are at least 19 years old in these regions.

The only person that can contribute and withdraw funds to and from a TFSA is the account holder. However, an individual is allowed to give money to a spouse of a common law partner for them to contribute to their own TFSA. The subsequent withdrawal will be entitled to the spouse, not the individual who gave them the money.

An individual can hold more than one TFSA on their name, and the accounts do not have to be held in the same institution. However, the total amount contributed on all TFSA accounts cannot exceed the allowed contribution room.


2. How to Open a TFSA?

Various financial institutions offer TFSAs. These include banks, credit unions, insurance and trust companies. The application process includes contacting one of these institutions and disclosing your SIN so they can register your qualifying arrangement as a TFSA.


3. TFSA Contribution Limits

The TFSA has certain contribution limits for each year an individual can contribute. All contribution limits for each year after the TFSA came into existence in 2009 can be found in the table below:


Annual Contribution

2009 to 2012


2013 and 2014




2016 to 2018


2019 to 2022


Table 1. Annual Contribution Limits to a TFSA


The contribution limits are indexed to the inflation rate and rounded to the nearest $500. If individuals contribute more than their contribution room, they will be subject to a 1% tax on the additional amounts invested calculated monthly.

The contribution room is calculated as the sum of the remaining contribution limit for the year and all contribution limits or freed up room in the account from previous years, after the individual has turned 18. That is, an individual who had turned 18 in 2009 or before and has never contributed to a TFSA can contribute the full $81,500 in 2022, which is the sum of all contribution limits for all years between 2009 and 2022 ($81,500 = 4*$5,000 + 2*$5,500 + $10,000 + 3*$5,500 + 4*6,000). Note that individuals who turn 18 during any year after 2008 can contribute the full annual contribution limit for that fiscal year. For instance, an individual turning 18 on June 8, 2022, cannot contribute to a TFSA before June 8, 2022, but is allowed to contribute the full $6,000 allowed for the year after June 8, 2022. Further, the contribution room also includes any amounts withdrawn from the account in previous years (but not the current year).


4. Qualified Investments

Various investments are allowed in a tax-free savings account. These investments are mostly the same as the ones allowed in an RRSP. They include cash, GICs (guaranteed investment certificates), bonds, mutual funds, stocks listed on a designated exchange, and certain stocks of small corporations. Foreign funds are also permitted, but they will need to be converted in Canadian dollars for reporting purposes.

One can also make in kind contributions by contributing assets they already own. These assets will be deposited at their fair market value, which may trigger a taxable capital gain if the fair market value is higher than the purchase price (yet a capital loss would not be tax-deductible). For instance, if an individual buys a stock of XYZ in 2021 for $100 and decides to contribute this stock to their TFSA in 2022 when that stock is valued at $120, the individual will need to pay tax on the capital gain of $20 ($120-$100). This contribution will be calculated on the fair market value; thus, this individual will need to have a contribution room of at least $120 in their TFSA in order to transfer the asset in the account.

One can also transfer an asset in a similar way from a registered retirement savings account. If the transfer happens immediately (the investor does not hold the asset outside of a registered plan before contributing it to a TFSA), the only tax that the investor will have to pay would be on the fair market value of the asset withdrawn from the RRSP according to the tax rules of RRSP withdrawals. This essentially means that one can transfer assets from a TFSA to an RRSP without triggering a taxable event, and the transfer would be considered a contribution to the RRSP and would qualify for a tax rebate.

An investor can also make transfers between different TFSA accounts held in the investor’s name, and these wouldn’t be considered as withdrawals.


5. Withdrawals

As already mentioned, withdrawals from a TFSA account also do not have any tax consequences. Investors are allowed to withdraw any amount of money from their account at any time completely tax-free.

Any withdrawal will also increase the contribution room in the TFSA accounts by the amount of the withdrawal effective the following year. For instance, if an investor with no contribution room in 2021 decides to withdraw $2,000 from their TFSA account, they will not be able to further contribute to the account in that year, but their contribution room for the following year (2022) will be the $2,000 freed up room from 2021 plus the annual contribution limit for 2022, which is $6,000, making it a total of $8,000 of contribution room for the investor in 2022. Note that if an investor has enough contribution room, they can re-contribute the withdrawn amount in the same year. For example, an investor with a $5,000 contribution room in 2021 withdraws $4,000 would be able to re-contribute $4,000 in their TFSA in 2021 as it does not exceed the contribution room, and they would still have an additional $1,000 contribution room. The contribution room for the following year in this example would be $4,000 of freed-up room plus the ending room of 2021 of $1,000 and the annual contribution limit for 2022, which is $6,000, making it a total of $11,000 for 2022.


6. What Gets Taxed?

The TFSA is virtually tax-free, however certain scenarios will have tax implications. The contributions to a tax-free savings account are not tax-deductible, which would mean that the contributions one makes will not decrease the taxes in the current fiscal year for that individual. For comparison, the RRSP contributions are tax-deductible, which essentially means that investors are deferring taxes by not paying them now when they are in a higher tax bracket, but they will be paying the taxes once they retire when their tax bracket will likely be lower.

There are also few exceptions when an investor would need to pay tax for using a TFSA. Some such scenarios were already outlined in this article, and they may include situations where one exceeds their contribution room or when one is not a resident for tax purposes. There are also taxes on prohibited or non-qualified investments of 50% of the fair market value of these investments, although a refund could be granted in some circumstances. For more information on these matters, please refer to the Canada Revenue Agency website.


7. When to Use a TFSA?

The TFSA is a very powerful tool available to the Canadian investor because it offers tax-free investment and growth, and it is very flexible in terms of withdrawal schedules. Investors could contribute to a TFSA as long as they are of age of majority (usually that would be 18 years old in most provinces) and are not exceeding their contribution room, without any upper age limit. Unlike the RRSP, which is mainly used for retirement savings, the TFSA offers investors the possibility to save money for various expenditures throughout one’s lifetime including making a major purchase like a house or a car, paying of loans, savings for entertainment like vacations and travelling, or just growing one’s capital tax-free, and having the freedom to withdraw the funds at any time. The TFSA has some shortcomings like the fact that the contributions are not tax-deductible. Thus, in certain situations one might be better off investing their money in a registered retirement savings account.

A situation when investors could prefer a RRSP is when they are in the highest tax bracket and need to defer their tax payments until later in their lives. Alternatively, an investor in a lower tax bracket who would not benefit much from deferring their taxes but would rather generate higher return in a TFSA would choose a TFSA. The investment horizon and goals are also important considerations. If an investor would need to withdrawal funds before retirement (either for a specific event they are expecting to happen or just for financial security in bad times), they should choose a TFSA, yet if they are solely planning for retirement savings, they might choose an RRSP. Thus, one’s personal situation should be carefully analyzed before deciding which type of account to invest in.


Author: Alexander Natchev

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