How Does a Tax-Free Savings Account (TFSA) Work?


How Does a Tax-Free Savings Account (TFSA) Work?

Tax-Free Savings Accounts—TFSAs

You can contribute up to $6,000 annually to your Tax-Free Savings Account. You can invest in stocks, exchange traded funds or mutual funds at Canadian financial institutions. Tax Free Savings Accounts (TFSAs) were introduced in 2009. TFSA contributions are not tax-deductible; however, you can withdraw the income earned in the TFSA and your contributions to it at any time tax-free.

What is TFSA contribution room?

You can contribute up to $6,000 per year to a TFSA if you are 18 or older and resident in Canada. If you have made no contributions to date and you are 29 or older in 2020, you can contribute a total of $69,500. You can carry forward unused contribution room indefinitely. You can hold more than one TFSA, subject to your contribution limit.

YearsTFSA contribution limit
2019-2012$5,000 per year
2013-2014$5,500 per year
2015$10,000 per year
2016 – 2018$5,500 per year
2019 – 2020$6,000 per year

What happens if you overcontribute to TFSA?

If you have an excess TFSA amount at any time in a calendar month, you are liable for a penalty tax of 1% of that month’s highest excess amount. Because the test applies at any time in a calendar month, withdrawing the excess amount will only stop the penalty from applying in the month after the withdrawal.

Is the interest on funds borrowed tax deductible?

Interest on funds borrowed and fees incurred to invest in a TFSA are not tax-deductible.

Income splitting benefit for families

TFSAs may offer an opportunity for income splitting for families in which one spouse has more income than the other. You can give funds to your spouse to contribute to his or her own TFSA, if your spouse has available contribution room.

Can you withdraw from a TFSA?

You can make a tax-free withdrawal from a TFSA at any time. The amount withdrawn is added to your contribution room, but not until the next year. You can re-contribute the amount you withdrew in the next year or later.

Example: Andrew contributed $63,500 to his TFSA before the end of 2019. In January 2020 he contributes $6,000 so that he has contributed the maximum amount of $69,500. He decides to withdraw $5,000 in June 2020 so that $64,500 of his contributions remains in his TFSA. In this case, he cannot re-contribute the $5,000 he withdrew until 2021. At that time, he can recontribute the $5,000 withdrawal along with his new contribution limit for 2021.

Investment income earned in Andrew’s TFSA is treated the same way. If Andrew’s $6,000 investment in 2020 earns $300 and he withdraws the $6,300 in December 2020, he can re-contribute the entire $6,300 in 2021 along with his new $6,000 contribution limit for that year, or $12,300 in total.

Similarly, if you invest some of the funds in your TFSA in the stock market and your share investment appreciates rapidly, say from $20,000 to $30,000, you could sell the shares and realize the $10,000 tax-free capital gain in the TFSA, withdraw the $30,000 cash proceeds and still be able to re-contribute the full $30,000 amount to the TFSA along with any other unused TFSA contribution room in the following year or later.

As a result, you could potentially contribute much more than the contribution limit annually, and therefore earn more tax-free investment income.

Consider contributing to investments that are expected to increase significantly in value over a short time in a TFSA. You can withdraw the income and capital gains earned tax-free at any time, and any withdrawals you make will create additional contribution room.

When choosing your investments, keep in mind that capital losses realized in a TFSA cannot be claimed against capital gains realized outside the TFSA.

What types of investments can I hold in my TFSA?

TFSAs can hold cash, guaranteed investment certificates (GICs), term deposits, mutual funds, exchange traded funds (ETF), and publicly trade securities (stocks) at financial institutions.

Where should you invest your savings?

You should decide on your best tax strategy for dividing your investments among TFSA, RRSPs (Registered Retirement Savings Plans) and RESPs (Registered Education Savings Plans). You’ll need to weigh these advantages against the benefits of other tax-assisted savings plans such as RRSPs and RESPs and other financial priorities such as paying down your mortgage.

Generally, if you have enough resources, you should invest in all the relevant plans. Though TFSA savings are initially limited, as contribution room increases, a TFSA may become a much more significant supplement to your RRSP.

Helpful savings scenarios:

RRSPs versus TFSAs

A TFSA is like a mirror image of an RRSP: RRSP contributions are tax-deductible, but the contributions and investment earnings are taxed when you withdraw them. TFSA contributions are not tax-deductible, but withdrawals of contributions and investment income are tax-free.

As such, your best tax strategy for dividing your investments between TFSAs and RRSPs may depend on any differences between your current tax bracket and the one you expect to be in when you start withdrawing funds from your RRSP.

If you expect your future income to fall into the same tax bracket as your current income, the tax benefits of a TFSA and an RRSP will be similar. That is, the value of the tax deduction for an RRSP contribution will generally equal the value of withdrawing funds tax-free from a TFSA.

If you expect your future income to fall into a lower tax bracket than your current income, an RRSP investment can provide a tax advantage because the tax deduction you get today will be more than the tax you will pay when you withdraw the money from your RRSP.

If your income falls into a lower tax bracket now but you expect it to be higher in the future, a TFSA offers a greater tax benefit because you would pay a higher tax rate on RRSP withdrawals than you will pay today on the income you contribute to the TFSA.

TFSAs for seniors

Unlike an RRSP, which must be wound up when you reach age 71, you can maintain your TFSA for your entire lifetime and so your TFSA should be integrated with your retirement income plan.


If you’re saving for your child’s education, keep in mind that, unlike a TFSA, a RESP offers an annual guaranteed rate of return of $500 (20% on $2,500 annual contributions) via the federal government’s Canada Education Savings

Once your children turn 18, you may want to consider giving them funds to invest in their own TFSAs to help finance their post-secondary education or other expenses.

TFSA versus mortgage paydown

If you’re considering whether to invest in a TFSA or pay down your mortgage, once you’ve taken all the relevant factors into account, it probably makes sense in most cases to reduce your non-deductible mortgage interest as soon as possible.

Additional TFSA resources

Government of Canada – The Tax – Free Savings Account

TD TFSA Calculator

ROYAL Bank TFSA Calculator

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