Tax-Free Savings Account Canada | Guide to Choosing the Best TFSA for Your Needs

August 3, 2021 | Editorial Team

Many people avoid thinking about their savings because they don’t have any. We can often get caught up with our day-to-day financial needs that thinking about the future gets forgotten. Fortunately, it’s never too late or too early to start saving!

One of the best ways to start is by opening a tax-free savings account (TFSA). Any Canadian over 18 can open a TFSA to start saving, tax-free!

Tax-Free Savings Account – Full Guide To Choosing the Right TFSA for Your Needs

If you’ve never heard of a TFSA before, don’t worry! In this article, we’re going to look at the ins and outs of a TFSA, so keep reading and you can start saving today.

What is a Tax-Free Savings Account

A tax-free savings account (TFSA) is a type of registered investment/ savings account where nothing in it is taxed. Tax-free savings accounts were created by the Canadian government in 2009. They created the program to encourage Canadians over 18 to save money, tax-free.

Every person with a TFSA has a certain amount they can deposit every year called their contribution room. We’ll discuss the contribution room in more detail later on in this article.

Any contributions you make to your TFSA can not be deducted for income tax purposes. Neither can any fees associated with your TFSA. Anything you deposit or withdraw, however, will be tax-free. Similarly, any income earned will still be tax-free as well. This includes interest or income from investments or capital gains in your TFSA.

To open a TFSA, you simply need to be a Canadian over the age of 18 with a valid SIN card. Financial institutions, credit unions, and even insurance companies can help you open a tax-free savings account.

How to Choose the Right Tax-Free Savings Account

If you are considering opening a tax-free savings account, you have to think about what type would be the best for you. There are five main types of TFSA investments. The first is a basic TFSA where you can simply deposit money, usually with a low-interest rate. This will help your money slowly grow at no-risk.

The next is a Guaranteed Investment Certificate (GIC) TFSA. A GIC will guarantee you earn a specific interest rate for a specified time. For example, 1% over one year. You can thus open a GIC within a TFSA, and the interest you earn on your money will be tax-free.

If you’re looking to make bigger investments, an exchange-traded fund (ETF) TFSA may be better. ETFs are investments that consist of stocks, bonds, and commodities. It’s a moderate-risk investment, but the earning potential is high. Investing in ETFs within your TFSA means your earning potential is even higher as the money will be tax-free.

You can also invest in stocks, bonds, or mutual funds within your TFSA. These tend to be higher-risk investments, so they should only be attempted by those with investment experience. Stocks, bonds, and mutual funds, however, can help you earn more money, especially within a TFSA.

Ultimately, the right tax-free savings account for you depends on how much of a risk you’re willing to take with your investments.

How Does a TFSA Contribution Limit Work

Every year, there is a maximum amount that you can contribute. This is called your contribution room. Any contributions made to any of your TFSAs, even if you withdrew money and re-contributed it, counts towards your contribution room.

If you go over your yearly contribution limit, you will have to pay a 1% tax each month you’re over the contribution limit. If you have unused contribution room at the end of the year, you can simply use it the following year. All unused contribution room will continue to roll over every year.

The contribution limit typically changes each year. For example, in 2020 and 2019, it was $6,000. In 2017 and 2018, it was $5,500. So, for example, if you deposited $500 in 2017 and have not deposited anything since your contribution limit would be $22,500 in 2020.

You can find the specific amount of your contribution limit through the CRA. Look for the ‘contact us’ section on their website or log in to your account.

Other Types of Savings Accounts

Traditional Savings Account

A traditional savings account is a type of bank account where you can deposit funds to save. Most people tend to have a chequing account for daily transactions paired with their savings account to transfer funds that they want to save to.

Some traditional savings accounts offer you interest, but it is typically low. You can open traditional savings account at most financial institutions and credit unions.

Opening an account for your savings is a good way to keep your funds safe. It will help encourage you to budget better as well.

High-Interest Savings Accounts (HISAs)

High-interest savings accounts (HISA) are similar to traditional savings accounts. The main difference is the interest rate. A HISA typically has a higher than the average interest rate, sometimes 20 to 25 times higher than a traditional savings account. In Canada, HISAs with interest rates as high as 1.50% are currently available.

High-interest savings accounts tend to have more restrictions as well. For example, you may need to maintain a minimum balance to avoid being charged. Or, if you want to withdraw funds, you may have to pay a fee. This is meant to encourage you to save more.

Registered Retirement Savings Plan (RRSP)

A registered retirement savings plan (RRSP) is another type of savings account offered by the Canadian government. It has been around since 1957 to help Canadians save for their retirement.

It helps Canadians save, as any money you contribute to your RRSP will be exempt from your income tax that year. Instead, you will have to pay tax on the funds when you withdraw them.

The contribution limit for an RRSP is 18% of your income for the year or a specified amount. For example, the limit in 2020 was $27,230. Your limit is whichever amount is smaller.

TFSA vs. RRSP: Which One is Right for You?

A TFSA and an RRSP are both great options for a savings account. Many people choose to open both savings accounts, but if you want to open one, here is the main difference between both accounts.

  • With an RRSP, you will get a tax refund on your income tax from the money you contribute. When you withdraw from your RRSP, you will then have to pay tax.
  • Some RRSPs also limit when you can withdraw from your account, sometimes charging a fee if you want to withdraw your savings early.
  • With a TFSA, you pay tax before you contribute the money, so when you withdraw it, you aren’t paying any more taxes.

Essentially, the main difference is when your income is being taxed, before or after you contribute it. This means that you will likely earn the same amount, no matter what type of account you choose.

As both account types have different contribution limits, having both can be beneficial. You may even end up with a larger amount of savings than you thought!

The Bottom Line

If you are looking to increase your savings, opening a TFSA may be a good option for you. Opening a TFSA is free and simple. You only need to be a Canadian over the age of 18 with a valid SIN card. The earlier you open your TFSA, the better because your contribution room will grow every year. But, it’s never too late to open one to start saving!

You can also use your TFSA to make a variety of investments. You can deposit cash, mutual funds, GICs, bonds, and stocks into your TFSA. This will help you earn more on your investments as you won’t be paying taxes. Just don’t forget what your contribution limit is, or you will be stuck paying 1% every month you’re over.

Financial institutions, credit unions, and insurance companies can all help you open your TFSA. Simply look for the ‘contact us’ section on any of their websites for more information on opening your TFSA.

If you are looking for other ways to save, traditional savings accounts, high-interest savings accounts, and a registered retirement savings plan are all great options. It’s never too early or too late to start saving, so why not start today?