Tax-free savings accounts (TFSAs) are nothing new; they’ve been around for a little over a decade now. Yet, despite the fact that they’re well-received by most Canadians, they’re still underutilized or misunderstood.
There’s a lot to like about TFSAs. For starters, they’re an excellent savings tool, whether you’re saving for retirement or any other purpose. They’re also great for investing. In fact, TFSAs are compatible with virtually all the investment assets associated with registered retirement savings plans (RRSPs)
What’s more, TFSAs allow you to withdraw money whenever you want. And as the name suggests, all of the dividends, interest, and capital gains that are earned in a TFSA aren’t subjected to any taxes.
If you’re interested in opening a tax-free savings account, we urge you to stick around, as we’re about to cover all you need to know about TFSAs, from their rules and regulations to their pros and cons. We’ll also shed light on some of the best TFSA investments you can opt for. In addition, in our earlier posts, we looked at TD Bank savings accounts, Tangerine Savings Accounts – see also Oaken Financial Reviews.
TFSA Accounts – What Do You Need To Know?
TFSAs are government-sponsored investment accounts that enable you to save or invest money up to a certain amount. The TFSA program was introduced by Jim Flaherty, Canadian Minister of Finance, in 2008. It came into effect in January of 2009. It’s only accessible to Canadians who are over the age of 18 and have a valid social insurance number.
One of the many reasons why TFSAs are increasing in popularity is that they allow for free-of-tax earnings, whether you’re saving or investing. Further, TFSAs allow you to roll over unused contributions into future years.
Despite the many perks that it has to offer, the tax-free savings account is somewhat underutilized. This stems from the confusion associated with the name chosen for this type of account by the federal government.
See, not all TFSAs come in the form of a traditional savings account. In addition to holding money, TFSAs can hold investment assets like bonds, individual stocks, GICs, mutual funds, and ETFs. In fact, TFSAs can hold any investment asset that a registered retirement savings plan can hold.
The main difference between TFSAs and RRSPs, in this case, is taxes. With a TFSA, your earnings aren’t subjected to taxes when you make a withdrawal. This isn’t the case with an RRSP
RRSPs do offer a valuable perk that TFSAs don’t offer, though. They allow you to claim contributions as deductibles on your tax return. This should be taken into consideration if you’re not sure whether you should opt for an RRSP or a TFSA.
Versatility-wise, TFSAs are much more versatile and flexible than RRSPs. They enable you to save money for just about any practical purpose, be it retirement, vehicle purchase, vacation, or wedding.
What’s more, TFSAs are super easy to open and navigate. You simply choose a TFSA product, register an account, and just let it earn. When the time comes, you can withdraw your money without worrying about taxes or penalties.
Bear in mind that TFSAs have a contribution limit that governs the maximum amount of money you can hold in a single account. You can contribute more than the maximum amount, but you’ll be taxed a monthly 1% on the highest excess.
The TFSA contribution limit changes on a yearly basis. In 2021, the contribution limit is $6,000, with a lifetime contribution limit of $75,500. Any income that’s earned on your TFSA isn’t counted as part of the contribution limit.
Is A High-Interest TFSA Account A Good Idea?
It depends on your saving goals. If you’re a short-term saver, then yes, a high-interest account is a good idea because your interest will grow without being subjected to any taxes.
We wouldn’t recommend making significant changes to your TFSA stash on a frequent basis because you may end up losing track of your contribution limit, which, in turn, may subject you to a monthly tax.
If you’re more concerned about fixed long-term savings, then we wouldn’t suggest a high-interest TFSA. Instead, we’d suggest a guaranteed investment certificate (GIC) within your TFSA.
GICs enable you to earn tax-free interest without altering your principal. The earned interest won’t be subjected to taxes as long as it’s inside your TFSA. It also won’t be subjected to taxes when it’s time to withdraw the funds.
Whether you choose to opt for a high-interest savings account or a GIC, we highly recommend doing plenty of research beforehand so that you can find the best rates and ensure the most value.
Tax-Free Savings Account – Rules And Regulations
It’s important that you learn about the regulations associated with TFSAs before you opt for one. In this section of the article, we break down TFSA’s rules and regulations with respect to eligibility, withdrawals, transfers, how much contribution room they offer, and more.
As of 2021, the contribution limit for TFSAs stands at $6,000, meaning the maximum amount of money that you can stash in your TFSA on an annual basis is $6,000.
Keep in mind, however, that the total amount of money that you contribute is cumulative, which basically means that unused contributions will roll over into future years.
You should also keep in mind that your investment earnings aren’t considered part of your annual contribution. The only amount of money that has a limit is the amount of money you put in.
If you currently don’t have a TFSA, it’s possible to contribute a grand total of $75,000 without having to pay tax, provided you were at least 18 years old with a valid social insurance number in 2009, which is the year the TFSA program went into effect.
Please note that over-contributing to your TFSA will subject you to a monthly tax of 1% on the highest excess. So, make sure you stay within the confines of your contribution limit so that you don’t lose money.
Like we mentioned earlier, the TFSA program is accessible to Canadians who are over the age of 18 and have a valid SIN number.
If you’re a non-resident Canadian with a valid SIN number, you can still open a TFSA, but all of your TFSA contributions will be subjected to a 1% tax paid monthly.
Please note that the age of majority in certain provinces, like New Brunswick, British Columbia, Northwest Territories, and Nova Scotia, is 19 years old.
If you live in one of those provinces, you’ll still accumulate TFSA contribution room from when you turn 18 years old, but you won’t be able to open a TFSA until you turn 19.
You can withdraw any amount of money you want from your account without worrying about the year’s contributions getting reduced. Your withdrawals will only be added back at the beginning of the following year. This doesn’t apply to specified distributions and qualifying transfers, though.
It’s possible to re-contribute the money you withdrew so that the following year’s contribution limit isn’t affected, but you can only do that if you have enough contribution room this year.
Withdrawing funds from a TFSA and depositing them into another TFSA will be considered as over-contributing if the latter TFSA account doesn’t have enough contribution room.
That being said, if you wish to transfer funds between different TFSA financial institutions without affecting your contribution room, you’ll need to ask your financial institution to carry out a direct transfer on your behalf.
When it comes to investing, TFSAs are a lot similar to RRSPs in the sense that they accept cash, GICs, mutual funds, stock exchange securities, and small shares. You can even contribute foreign funds into your savings account, but their value will be converted to Canadian dollars.
Just because an investment asset is held in your TFSA doesn’t make it immune to losses. Your assets can still incur losses, but the losses won’t be considered part of your contribution room.
It’s also worth noting that foreign investment assets that pay dividends are subject to taxes even in a TFSA. It’s called a non-resident withholding tax, or NRT for short.
When you decide to open a TFSA, you’ll be required to name a person (beneficiary) who will inherit the funds in your TFSA in the event of your death.
The funds inherited by the beneficiary won’t be considered as income, and so they won’t be subjected to taxes. Note, however, that any TFSA earnings generated after your death, including interest, capital gains, and dividends, won’t be tax-free.
If you’re in a common-law partnership or if you’re married, you can name your spouse or partner as your successor holder. This way, in the event of your death, your partner or spouse will become the new owner of your TFSA, which will then keep the account’s tax-free status intact.
The Best TFSA Investments
Now that you have a solid understanding of what TFSAs are all about, as well as their rules and regulations, it’s time to discuss the best TFSA investment options you can opt for.
There are three categories of TFSA investments you should consider, namely traditional low-risk investments, self-managed accounts, and robo-advisor accounts (see ‘Best Robo Advisors‘). Let’s break down each investment.
1. Traditional Low-Risk Investments
Traditional low-risk TFSA investments refer to TFSA savings accounts and GICs. Savings accounts are ideal if you’ll need your funds within a short period of time—a year or so. GICs, on the other hand, are ideal for longer durations of 1-5 years.
Currently, EQ Bank offers one of the best TFSA savings accounts, with an interest income of 1.25%. EQ Bank also offers great GIC rates that range between 1.3% and 2.1%, depending on the duration of the investment.
2. Self-Directed Accounts
If you’re an experienced investor, a self-managed TFSA account is going to be your best bet, as it’ll allow you to designate the assets you want to hold in exact proportions. Further, self-directed TFSA accounts come with lower management fees and higher returns than other types of investments.
An example of a self-managed TFSA account is a discount brokerage account. This type of account enables you to buy and sell mutual funds, stocks, ETFs, and other types of assets with ease. Questrade and Wealthsimple Trade are two names you should consider when it comes to opening a discount brokerage account (see also ‘Best Online Brokerage‘).
The best assets to trade with a self-managed account are exchange-traded funds, or ETFs for short. They’re quite similar to mutual funds, but they’re cheaper and are traded similarly to stocks.
Trading ETFs will help diversify your investment portfolio, considering the fact that a single ETF can hold hundreds or even thousands of bonds or stocks. Just make sure you’re mindful of the trading fees. Moreover, your portfolios could prosper from adding silver stocks and ETFs, but that is a topic for another post.
Not interested in ETFs? The second-best assets you can trade are stocks. Trading stocks is insanely easy with a discount brokerage account, in fact. However, investing in stocks can be risky, so make sure you know what you’re doing – see ‘How to Find Undervalued Stocks’ post.
Another type of asset that you should consider is mutual funds. Not only are they great for a TFSA, but they’re also excellent for an RRSP or a non-registered investment account.
3. Robo-Advisor Accounts
TFSAs aren’t limited to traditional savings and self-managed accounts; robo advisors, also known as online wealth managers, also offer TFSAs via low-cost exchange-traded funds.
A robo-advisor TFSA grants you access to professional money management services at a fee that’s pretty insignificant compared to the fees associated with traditional wealth management services. Robo-advisor fees come at an average of 0.75%. The fee is inclusive of management and ETF MERs.
Robo-advisor accounts are excellent for people who don’t know much about investing. Robo-advisors determine your investment objectives as well as your risk tolerance by asking you a series of relevant questions. Thereafter, they set you up with a personal finance portfolio that meets your investment needs.
You can view robo-advisor accounts as opposite to self-directed accounts. A robo-advisor helps you rebalance your TFSA investment portfolio if need be, whereas a self-directed TFSA account is, well… self-directed!
So, which robo-advisor should you opt for? Well, there’s no better option than Wealthsimple Invest. It’s, in fact, the most popular robo-advisor in the country. If you seek the lowest robo-advisor fee, however, opt for Questwealth.
Pros And Cons
While there are several advantages to opening a TFSA savings account, there are a few disadvantages that must be taken into consideration. Here are the pros and cons of TFSAs:
- Tax-free compounding. As the name suggests, tax-free savings accounts don’t subject your investments to taxes. So, let’s say you contribute $3,500 to your account each year. After 40 years of contributing, you’ll enjoy a $358,963 growth with zero taxes.
- Shared contribution room. It’s possible to share your account’s contribution room with your spouse or common-law relationship partner so that you help maximize their tax-sheltered saving space. This feature isn’t available in RRSPs.
- No mandatory withdrawals. While RRSPs force withdrawal rates upon Canadians over the age of 71, TFSAs don’t force any mandatory withdrawals, meaning you can let your TFSA funds grow free of taxes for the entirety of your life.
- Plenty of investment options. TFSAs are compatible with just about any investment asset that you can put in an RRSP, including bonds, individual stocks, mutual funds, index funds, GICs, and cash.
- Unused contribution room doesn’t expire. You don’t need to max out your contribution room with a TFSA. You can put whatever amount of funds you want and have the rest of the contribution room carry over to the following year.
- Unconditional withdrawals. With a tax-free savings account, you can withdraw your money at any given time without worrying about withholding taxes. What’s more, your withdrawals won’t impact your government benefits, whether it’s Old Age Security, Canada Child Benefit, Employment Insurance, or Guaranteed Income Supplement.
- TFSA contribution limit is unrelated to income. No matter your income, your TFSA’s contribution room will remain the same. This isn’t the case with an RRSP, with which your yearly contribution room is directly related to your income.
- TFSA contributions aren’t tax-deductible. This is one aspect that sets RRSPs apart from TFSAs. With a TFSA savings account, your contributions aren’t tax-deductible, which means that your taxable income won’t be reduced no matter how much you contribute. The opposite is true with RRSPs.
- US-based dividends are subject to taxes. Another major TFSA disadvantage is that any dividends generated by a US-based company in your account will be subject to a withholding tax of 15%. This isn’t the case with an RRSP, though.
- No grace amount for over-contributions. If you over-contribute to your TFSA, even by a single dollar, you’ll be penalized with a 1% tax by the CRA. The tax is applicable on the excess amount alone, though.
- No creditor protection. In the event of bankruptcy, the funds or assets within your savings account won’t be protected from creditors. If you seek protection from creditors, your best bet is an RRSP.
- Day trading isn’t allowed. Day trading within a TFSA savings account isn’t condoned by the CRA, which is understandable considering the TFSA program is intended to generate investment income, not business income.
What Type Of Investment Is Best For TFSA?
Cash is the simplest and most conservative type of investment for TFSAs. Simply keep your cash in your TFSA and let it generate interest income. The higher your savings account’s interest rate, the more money you’ll generate.
Guaranteed income certificates (GICs) are also an excellent type of investment for TFSAs, especially if you champion low-risk investments. With a GIC, you’ll be paid a fixed interest on your invested principal (100% protected).
Which Bank Has The Highest TFSA Interest Rate?
The highest TFSA interest rate is offered by WealthOne, which is a CDIC-insured Schedule I bank. WealthOne is a digital bank, but it has retail locations in Vancouver, British Columbia, Ontario, and GTA. Their high-interest savings account comes with an interest rate of 1.50% (see also ‘Best Online Banks‘)
What Types Of Investments Are Allowed In TFSA?
TFSAs accept a wide range of investments, including cash, designated stock exchange securities, mutual funds, guaranteed investment certificates, corporate bonds, and small shares.
The Bottom Line
To sum up, TFSA savings accounts are government-sponsored investment accounts that are available to all Canadians over the age of majority, which can be 18 or 19 years old, depending on your province.
TFSAs enable you to save or invest funds or assets up to a certain amount. As of 2021, said amount is set to $6,000. In addition to cash, you can put mutual funds, stock exchange securities, GICs, bonds, and small shares in your TFSA.
TFSAs investments come in three categories: traditional low-risk investments, self-directed accounts, and robo-advisor accounts. Each type of investment comes with its own set of advantages and disadvantages, so be sure to weigh each option properly before opening a TFSA.
Generally speaking, savings accounts and GICs, which fall under the traditional low-risk investments category, are considered ideal TFSA investments because they enable you to earn at a virtually non-existent risk.
If you’re an experienced investor, self-directed accounts are your best TFSA investment option. If you need help managing your portfolio, however, opt for a robo-advisor account.