What is a tax-free savings account?

Updated: Sep 16, 2020

A tax-free savings account (TFSA) is a government-sponsored investment account.

A TFSA allows you to pick what financial instruments to include in your account including exchange traded funds, guaranteed investment certificates, stocks, bonds and savings accounts. Whatever gains you make from the investments in your account are tax-free (hence the name).

The Canadian government introduced TFSAs in 2009 as a way to encourage people to save money for retirement. Since you paid tax on the money you put into your TFSA, you won’t have to pay anything when you take money out.

There’s a limit to how much you can put into a TFSA, of course. You can contribute up to a government mandated amount each year. In 2020, that amount is $6,000. You’re eligible to start as soon as you’re 18 years old.

The main benefit of a TFSA is that you don’t have to pay tax on the money you put in. If you invest $1,000 right now and it becomes $10,000 by the time you retire, that $9,000 you’ll have earned is tax-free.

Second, unlike your Registered Retirement Savings Plan, your TFSA allows you to quickly and easily take money out any time you want. There is no penalty to withdraw money— and if you do, the amount is added to how much you can contribute the following year. For example, withdrawing $5,000 this year means that next year you’ll be eligible to contribute the normal $5,500—plus $5,000.

A bonus for retirees: The money you withdraw from a TFSA isn’t considered income, so retirees can take money out without it affecting retirement benefits like Old Age Security, which decreases with higher income.

Because TFSAs are so popular and plentiful and you can open as many as you want, it’s easy to lose track of how much you’re contributing. If you accidentally over-contribute (i.e., put in more money in a calendar year than you’re allowed by law), you will be charged a penalty of 1% per month on the amount in your TFSA that is in excess of the limit. This is a great reason to work with a financial coach to help keep track of your contributions.

Finally, remember that you can’t day-trade stocks in your TFSA.

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