How does a TFSA work?

What is a TFSA? The Ultimate Guide

A Tax-Free Savings Account (or TFSA for short) is a type of registered tax-advantaged account. Every Canadian over the age of 18 is eligible to open a TFSA.

As the name suggests, using a TFSA can save you thousands in taxes because the government is giving you the opportunity to earn tax-free income (importantly, including investment income).

This introductory guide answers common TFSA questions and dives into the essentials that every Canadian should know about the TFSA. By the end of this article, you will be well equipped with the knowledge required to open your own TFSA and start making tax-free income.

How Much Can I Contribute To My TFSA?

The amount of money you can contribute to your TFSA is known as your contribution limit. Your contribution limit increases each year based on the table specified below, starting from the year you turn 18 years old.

The TFSA was introduced in 2009, so if you were over the age of 18 back in 2009, then your total contribution limit would be the sum of the all the yearly contribution amounts shown below.

Year TFSA Contribution Limit
2024 $7,000
2023 $6,500
2022 $6,000
2021 $6,000
2020 $6,000
2019 $6,000
2018 $5,500
2017 $5,500
2016 $5,500
2015 $10,000
2014 $5,500
2013 $5,500
2012 $5,000
2011 $5,000
2010 $5,000
2009 $5,000

A great feature of the TFSA is that unused contribution limit carries over every year. That means that even if you have never used a TFSA before, then you would still be able to contribute up to your entire cumulative contribution limit.

Keep in mind that you’re allowed to have multiple TFSA accounts, but the cumulative contribution room across all your TFSA accounts cannot exceed your contribution limit.

Your available contribution room is the remaining amount of money you can contribute before reaching your contribution limit. It decreases by the amount that you contribute into your TFSA. When you run out of contribution room, you have reached your contribution limit.

The Canada Revenue Agency (CRA) keeps track of your individual contribution room at the start of every year, however it is not updated until midway though the year. To view the contribution room that CRA has on your file, log into your CRA account and then scroll down to the “RRSP and TFSA” section, where you can view your contribution room as of January 1st of the current year.

Check out our free TFSA Contribution Room Calculator to easily keep track of your own contribution room.

Since it takes several months for CRA to process last year’s contributions and withdrawals, you will want to use this spreadsheet to avoid overcontribution.

How Do Withdrawals Affect My Contribution Room?

An important distinction between a TFSA and an RRSP is that when you withdraw from a TFSA, that contribution room is not lost forever. Instead, the amount that you withdrew is added back to your contribution room on January 1st of the following year.

Be wary if you’re transferring money between TFSA accounts by withdrawing cash from one account and contributing into the other. If you transfer money this way, then you won’t be able to recover the TFSA contribution room until next year.

To illustrate how withdrawals affect your contribution room, consider the following example.

TFSA Contribution Room Example

The freedom of being able to withdraw money at any time without penalty is, in theory, a tremendous benefit of using a TFSA over a Registered Retirement Savings Plan (RRSP).

In reality, it can be more of a double-edged sword. The TFSA was designed to be a long-term savings vehicle, and the temptation to withdraw money in order to access cash quickly can be detrimental to your financial goals.

Therefore, in addition to a TFSA, it may be beneficial to also have an emergency fund worth 3-6 months of expenses in a regular savings account to help prevent unplanned withdrawals from your TFSA.

Should I Treat A TFSA Like A Savings Account?

This is a common source of confusion when it comes to the TFSA.

You might guess that it functions like a regular bank savings account, except that you don’t have to pay taxes on any interest.

Unfortunately, its deceptive name does a good job concealing the true benefits of this type of account.

In fact, a TFSA is far from just a place to park your cash. To truly capitalize on the potential of a TFSA, it should be considered an investment account. Unlike your typical savings account where you simply hold cash, you can use a TFSA to buy equities like stocks and bonds.

Therefore, a TFSA is an excellent vehicle for long-term investment purposes, such as saving for retirement.

Using a TFSA in this way is where you can unlock its true potential – your capital gains from compounding returns are tax-free.

Here is an example illustrating the difference between holding cash vs. investments over time, comparing a 1% savings interest rate to a 7% annualized average return on an investment portfolio.


At first, the difference looks pretty negligible. However, the effects of a higher annualized rate of return are astronomical over a longer time horizon.

Keep Investments in Your TFSA – Not Cash

The main benefit of a TFSA is that capital gains, dividends, and all other investment earnings within the account are completely tax-free.

In the long run, opening a TFSA instead of a non-registered investment account can amount to thousands of dollars saved in capital gains and dividend taxes.

With a non-registered account, you need to pay capital gains tax. With a TFSA, you pay zero Canadian tax on investment gains.

Withdrawals from a TFSA also are not taxed since contributions are done with after-tax income (unlike an RRSP).

Over a typical investor’s time horizon, how much can a TFSA really save in taxes?

Let’s suppose you invested $5000/year in index funds for 20 years and averaged a 7% annualized return, before withdrawing everything from your account to make a down payment for a new house.

At this point, your portfolio would be valued at an impressive $204,977.46, with $5,000 x 20 years = $100,000 of that being your contributions, and the remaining $104,977.46 being capital gains.

If your average tax rate is 30%, then you would have just saved $15,747 in taxes because you paid no capital gains tax! The same cannot be said if you tried this with a non-registered account: you would be liable to pay the capital gains tax.

TFSA Tax Savings

This comparison really demonstrates the potential tax savings you could be missing out on if you don’t use a TFSA.

You should only use non-registered accounts after you’ve maxed out your TFSA and RRSP. Non-registered accounts have no contribution limit.

Don’t know how or where to get started investing? Check out our step-by-step guide on how to get started buying stocks in Canada.

Withdrawing Profits & Losses From A TFSA

Let’s say you contributed diligently over many years, and were also blessed with the good fortune of profitable stock picking. As a result, your TFSA has managed to appreciate to a value of $200,000 and you’re ready to withdraw it all.

Surprise, surprise – you would be paying no Canadian taxes when making your big withdrawal!

In fact, every dollar you withdraw, whether it be your initial investment, capital gains, dividends, or interest, increases your contribution room in the following year by that same withdrawal amount, no matter how large.

That’s right – in addition to the principal, withdrawing capital gains and dividends also increases your contribution room!

On the other hand, let’s say you caught the short end of the stick, and your speculative stock picking has caused your TFSA to plummet to $0, even though you had contributed up to the maximum limit.

In that case, unfortunately you would have nothing to withdraw and would not be able to deposit any more money until your contribution limit increases the following year.

U.S. Withholding Taxes

Although you don’t have to pay any Canadian taxes on profits, it should be noted that Canadians are required to pay a 15% withholding tax on dividend earnings from a U.S. stock.

This is because the tax-sheltered benefits of a TFSA are not recognized by the U.S., so you will still need to pay withholding tax if you earn U.S. dividend income. However, this is usually a relatively minor fee that is also built into most US-listed equities, so the typical investor doesn’t need to worry too much about U.S. withholding taxes.

What Happens If I Overcontribute To My TFSA?

Remember that your contribution room does not increase immediately after you withdraw money from your TFSA, but rather at the beginning of the following calendar year.

If you exceed your contribution limit, then you pay a 1% fee on the excess contribution amount for every month that it remains in your TFSA.

Use Your TFSA The Right Way

While the TFSA is great for investing purposes, it should not be used for the following reasons:

Don’t use a TFSA for…

  • Day trading – Conducting very frequent trades may be considered business activity instead of investment activity to the CRA. You may lose the tax-free benefits of the account if you’re perceived to be earning business income in your TFSA.
  • As an emergency fundEmergency funds are important to prepare you for sudden unexpected expenses. However, it would be more efficient to put your emergency fund in a traditional savings account. Only put your emergency fund in a TFSA if you have spare contribution room not being used for investments.
  • Holding cash for more than the short-term – As stated earlier, there is very little tax benefit from holding cash in a TFSA. Unless you have spare contribution room, you are foregoing the potential tax savings on capital gains and dividends resulting from investing.

How Can I Open A TFSA?

Ready to take full advantage of the tax benefits of a TFSA and save thousands of dollars along the way?

Depending on your needs, you can open a TFSA investment account and/or TFSA savings account.

Open A TFSA For Investing

You can always open an TFSA account with your bank, but if you’re using their investment platform, they often come with higher trading fees for the tradeoff of convenience.

If you’re looking for the overall best TFSA investing account, go with the self-directed Questrade TFSA. Along with having one of the cheapest trading fees in Canada, you can hold both CAD and USD currencies, allowing you to trade Canadian and U.S. stocks.

PROMO: $50 IN FREE TRADES

Questrade TFSA

– Canada’s leading discount brokerage
– Low costs and trading fees
– Commission-free ETF purchases
 
 
 
 
 

Open A TFSA For Savings

If you have spare TFSA contribution room and need a place to park your savings, it may make sense to open a TFSA for your savings.

Look no further than EQ Bank’s TFSA savings account. They offer one of the most competitive savings rates in Canada, and setting up an account is a straightforward process.

It’s Time To Save On Taxes

When used right, a TFSA is one of the most powerful tools that Canadians have at their disposal to further their financial aspirations.

I hope that this guide has equipped you with the knowledge to save thousands in taxes over your lifetime.

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5 Responses
  1. Hassan

    Hi Jason,

    I’m a bit confused with the definition of day trading in a TFSA account. If I buy US stocks, and sell them within 3 or 6 months and realize a capital gain; and then repeat that cycle; is that considered day trading?

    Thanks,
    Hassan

    1. Hi Hassan,

      There is no set definition of what constitutes as day trading in a TFSA, but CRA may investigate accounts by considering a variety of factors such as trade frequency, level of capital gains, etc.

      Buying and selling stocks within 3-6 months would definitely not be considered day trading – as long as you are not making daily trades or have deemed to have business activity within your TFSA, you are fine. The scenario you list here is perfectly valid within a TFSA.

  2. Spencer

    Hey Jason,

    I stumbled upon your blog this evening, was intrigued, and have read each post. As a fellow Canadian with a similar financial philosophy, I felt compelled to commend you on the comprehensive articles and clean design. It’s refreshing twist from the conventional blog as each of your posts provides the thorough analysis necessary for the topic, and your graphics and charts are look great and compliment the content perfectly.

    It’s clear you’ve put a lot of effort into this. I sincerely hope your blog gains the traction it deserves. Keep up the good work!

    1. Hi Spencer,

      I’m very glad that you had the opportunity to read over my blog and that a fellow financial enthusiast like you enjoys my articles! I really appreciate your feedback regarding the site design and the infographics. I try to make sure that every article I put out is thoroughly researched, as I truly believe that quality is more important than quantity.

      Thank you for your kind comments and I look forward to posting more content!

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