What Every Canadian Should Know about TFSAs

As a Canadian, a few things you should know about the Tax-Free Savings Account are:

  1. It can be both a savings account and an investment account. 
  2. Contributions made to this account (and earnings/growth on them) are not tax-deductible from your income. 
  3. There is a yearly contribution limit that can be carried forward. If you make a withdrawal in a calendar year, that amount is added to your contribution limit for later years. Be careful not to over contribute as there are significant penalties for excess contributions.
  4. Depending on your current (and future) tax bracket, investing in a TFSA may yield higher returns than an RRSP.
  5. Withdrawals from a TFSA do not count towards your income and subsequently will not reduce OAP and GIS payments

What is a TFSA and How Does it Work?

The Tax Free Savings Account (TFSA) was implemented by the Canadian Federal Government on the 1st of January, 2009 as a financial planning tool for Canadians 18 years and older with a valid social insurance number (SIN). What makes it unique is that any earnings and withdrawals made from the account are not subject to income or capital gain taxes. Foreign investments are the only exception as they can still be subject to withholding taxes. Unlike an RRSP, however, contributions are not tax-deductible.   

While its name might mislead you into thinking TFSAs are only to be used for savings, they can actually be highly tax-efficient investment accounts that allow you to contribute to a vast range of investments. 

Over ten years have passed since the introduction of TFSAs, but Canadians are yet to fully take advantage of the tax advantages they offer. Recent polls by the Royal Bank of Canada in 2019 found that TFSAs are being underutilized with 43% of Canadians using them only for savings rather than the tax-advantaged investment accounts that they are. Subsequently, many Canadians have not maximized their contributions, with an average unused contribution room of over $30,000 in 2017.

How much money can you contribute to your TFSA?

Each year, qualified Canadians can contribute a specific amount to their TFSA accounts. The maximum annual contribution changes based on the inflation rate of the Consumer Price Index (CPI) and is rounded up to the nearest $500.   

The maximum amount that can be contributed to your TFSA is called your contribution room. If you have never contributed to the TFSA, your contribution room starts from 2009 or from the year you become eligible by age or residency (i.e. the first time a contribution could have been made) up to the end of the current year. In 2020, the maximum contribution room you could have earned was $69,500. 

Contribution limits for the TFSA for each year since 2009


?: The contribution limit for 2015 was increased to $10000 in the 2015 budget by the Conservative party but was reset back to $5500 in 2016.

TFSA contributions, withdrawals, and overcontributions.

As an account holder, you are the only person who can make contributions to your TFSA or withdraw from it. Like other types of investment accounts, you can choose to have a self-directed TFSA where you determine how funds are invested, or you can decide to have a professionally managed portfolio. While you can have more than one TFSA, the sum of all of your contributions must not exceed the contribution limit.

Unlike the spousal RRSP,  you cannot contribute directly to your spouse’s or common-law partner’s TFSA. Instead, you can give your partner money to contribute to their own TFSA. Note that the money and any income or gains earned on those funds would be theirs as well.

You can also name your spouse as the successor holder of your TFSA, which allows them to take over the account without affecting their own TFSA status. This allows them to continue the tax-free growth of any investments within the account without any tax consequences. Only spouses or common-law partners can be named successor holders.  

What happens when there is no successor holder? If the TFSA is inherited (e.g. as part of the deceased’s will or as a beneficiary of the estate) by a surviving partner, the assets can be transferred to the partner’s TFSA within the rollover period (commences from the day of death till the 31st December of the following year). Transfers that take place during this period are called exempt contributions because they do not affect the receiving partner’s contribution limit. 

For other designated beneficiaries, the TFSA is liquidated and proceeds are given to the beneficiary. There is no tax on the withdrawal, but any gains made after the death of the owner will be subject to additional taxes.

When a withdrawal is made out of your TFSA, your contribution room for the next calendar year (but not the current year) increases by the withdrawal amount. This means that when your investments increase in value, your total TFSA room effectively becomes larger and any withdrawals, even if they are more than your initial contributions, can be re-contributed in future years. 

What happens when you make an excess contribution to your TFSA?

Over-contributions often stem from not fully understanding what happens when you make a withdrawal from your TFSA. If you made a withdrawal in 2019 for example, the available contribution room for 2019 still stays the same. If you maximize your TFSA contribution limit, you will be subject to penalties if you withdraw and then contribute again within the same year.

Any excess contributions will be subject to a 1% monthly penalty on the highest excess amount in the month for each month the excess amount is left in the account. This penalty will apply until you withdraw it or gain enough contribution room to allow it. Any gains or income earned from those excess contributions can also be subject to a 100% penalty, meaning that any return on excess contributions will be lost. 

Let’s assume Brenda makes her $6000 maximum contribution for 2019 in June, but then chooses to contribute another $400 in October, and another $400 in December. For October and November, she will be penalized $4 a month for a total of $8. For December, her total excess contributions will equal $800 so she will have to pay an additional penalty of $8 for that month for a total of $16. If she made a return of $20 on the excess contributions, it could all potentially also be taken away and make her total penalty $36. 

If the excess contribution isn’t withdrawn, you will keep incurring penalties until you get enough extra contribution room from the annual allocations. There is no overcontribution allowance or buffer for TFSA, in contrast to  RRSPs, where you can contribute up to $2000 above your contribution limit before being fined for an over-contribution. Keep track of your deposits and check official records to prevent an over-contribution.

If you are unable to contribute the maximum amount in a particular year, you can do so in the future. If you have a current contribution room of $6000 and you deposit only $4000, the extra $2000 would carry forward until you use it up. 

What kind of investments can you keep in your TFSA?

You can hold a large variety of investments in your TFSA, examples of which are cash of any currency, trust interests such as mutual funds and real estate investment trusts, ETFs, publicly traded shares, eligible shares of private corporations, annuity contracts and other forms of registered investments.  

According to an RBC poll, TFSA holders reported these top five holdings in their plans: savings accounts/cash (42%), mutual funds (28%), stocks (19%), GICs (15%), ETFs (7%).

Examples of short, intermediate and long term investments that can be kept in your TFSA include:

  • Short term: GICs, deposits in High-Interest Savings Accounts
  • Intermediate: Combinations of mutual funds and GICs, either via a professionally managed portfolio or as a self-directed TFSA
  • Long term: Stocks, ETFs, mutual funds.

What are the differences between a Tax-Free Savings Account (TFSA) and a Registered Retirement Savings Plan (RRSP)?

Over 2 out of 3 Canadians pick TFSAs over RRSPs, but both have their benefits and use-cases.

An RRSP helps you save on taxes by decreasing your taxable income and is typically a smarter choice if you are within a high tax bracket. In contrast, contributions to TFSAs are not deductible on your income tax return.

Another differentiating factor is whether earned income is required before you can contribute to either plan. For the TFSA, your contribution room is set to a constant amount every year while your RRSP contribution room is based on your income. This means if you are retired, unemployed or have a part-time business that isn’t making much profit, you would still be eligible to maximize your TFSA but might not have much room for your RRSP. 

You can withdraw from a TFSA at any time without any penalties. In contrast, withdrawals from an RRSP before the age of 65 will be subject to penalties (unless you use one of the approved withdrawal plans, like the Home Buyer’s Plan). 

A uniting feature of both plans is that they both allow you to grow tax-free earnings. However, your withdrawals from an RRSP are taxed while TFSA withdrawals aren’t taxed.  

The Canada Revenue Agency aptly described the relationship between a TFSA and an RRSP thus: “An RRSP is primarily intended for retirement. A TFSA is like an RRSP for everything else in your life.”

Is it better to put money in a TFSA or an RRSP?

If you are trying to make a decision between either a TFSA or an RRSP, you need to keep the above differences in mind. You should also review how soon you’d need to withdraw the money and your tax bracket at the time of withdrawal.   

For example, if you are likely to be in a lower tax bracket (e.g. at retirement) when taking money out of your savings/investment plan, an RRSP might be a better option for you as you wouldn’t have to pay much tax on your withdrawals. Since RRSP withdrawals are added to your taxable income, however, they could reduce the benefits you can get from other programs such as government benefits such as Old Age Security (OAS).  

Worthy of note is the difference in contribution room between the RRSP and TFSA. While the maximum contribution that could have been made towards your TFSA at the end of 2020 is $69,500 if you had been eligible since 2009, you could potentially contribute much more to your RRSP if you had earned regular income in the same period. For example, the annual contribution limit for TFSAs for 2020 is $6000, while the contribution limit for RRSPs for the 2020 tax year could be up to $27,230.

If you are thinking of buying a property soon, investing in an RRSP is smart as with the Home Buyers’ Plan, you can withdraw up to $35,000 from your RRSP to pay for your house if you qualify as a first-time homebuyer.   

Remember that the RRSP is only a tax shelter for your contributions, and any withdrawals are fully taxed.

Can you contribute to both an RRSP and a TFSA?

Yes, you can. To benefit the most from both accounts, you could make more contributions to a TFSA while you are in a lower tax bracket and bank up RRSP contribution space for when you earn a higher income in the future. The same RRSP contribution tax deductions give you a much higher return when you are at a higher tax rate compared to a lower one. A smart way to merge the benefits of both accounts would be for retirees to make small withdrawals from their RRSPs and maintain their low tax bracket and eligibility for government transfers and topping up with additional withdrawals from their TFSAs.


Because of its investment potential, the Tax Free Savings Account should really be called the Tax Free Investment Account.  Your TFSA can help multiply your funds vastly, but it's better if you start making those contributions when you’re in a lower tax bracket, so your earnings can accumulate over time.