What Is a TFSA: How Does a Tax-Free Savings Account Work

What Is a TFSA: How Does a Tax-Free Savings Account Work

A tax-free savings account, or TFSA, is a type of Canadian savings account that holds different kinds of investments and allows tax-free withdrawals. Canadians over the age of 18 with a valid social insurance number (SIN) are welcome to open a TFSA for any reason.

Table of Contents

What is a TFSA?

Canada initiated the first tax-free savings accounts in 2009. During this time, the contribution limit was $5,000 annually. The TFSA contribution limit increased to $5,500 in 2013 and did not increase again until 2015 when the limit became $10,000. Currently, the contribution limit sits at $6,000.

The primary benefit of a TFSA is that there is no tax on income within the account. Essentially, this gives Canadians the opportunity to save up to $6,000 without paying income tax on the funds.

Account holders need to remember that TFSA administration fees or contributions are not tax-deductible.

Types of Tax-Free Savings Accounts

TFSAs are flexible accounts that allow for various types of savings or income. Several different institutions can issue tax-free savings accounts, including banks, credit unions, and insurance companies.

TFSAs come in three primary forms:

  1. Annuity contract: Usually issued by an insurance company, an annuity contract is a legal document binding up to four parties. Essentially, this contract holds the insurance company liable for making regular payments to the annuitant once they retire or request the payments, making it a risk-free retirement fund.
  2. Deposit: A TFSA deposit account works the same as a standard savings account; holders deposit money into the account where it accrues interest over time. One of the benefits of this type of tax-free savings account is that holders can quickly withdraw money, making it useful for emergency funds and flexible spending.
  3. Arrangement in trust: A trust arrangement is an agreement in which a third party, such as a bank, holds assets for a beneficiary. Many holders prefer to use trusts over a will as beneficiaries have quicker access to the assets on hold. Additionally, trusts have the potential for reduced estate taxes and court fees.

Contacting a TFSA financial institution can help you determine which type of tax-free savings account is right for you.

What is the Difference Between TFSAs and RRSPs?

An RRSP is a registered retirement savings plan. As the name implies, its primary use is for retirement savings. On the other hand, a tax-free savings account allows for multiple types of savings ranging from investments to securities.

Aside from the accounts’ uses, TFSAs and RRSPs have contrasting tax requirements. Registered retirement savings plan deposits are tax-deductible. TFSA deposits, however, are not deducted from the account holder’s taxable income.

Similarly, TFSA withdrawals are not taxable, whereas RRSP withdrawals are subject to income tax.

TFSA Terms to Know

What is a TFSA? Understanding how a tax-free savings account works requires a basic knowledge of various TFSA-related terms.


Arm’s Length

Non-arm’s Length

Common-law Partner

Deliberate Over-Contribution

Qualifying Arrangement

Qualifying Transfer

Successor Holder

Who Can Open a Tax-Free Savings Account?

Any Canadian resident over 18 with a social insurance number is eligible to open and contribute to a tax-free savings account. A non-Canadian resident can also open a TFSA so long as they have a valid SIN.

Although non-residents are eligible to open a tax-free savings account, they are responsible for a 1% tax every month for their TFSA contributions. The only way for account holders to avoid the 2% tax is to become legal Canadian residents.


How Do You Open a TFSA?

Canadians can open a tax-free savings account at any time. The first step is to find and contact an issuing financial institution.

Multiple types of financial institutions can issue TFSAs, including:

  • Banks
  • Credit Unions
  • Insurance Companies

After contacting an issuing organization, you must provide your social insurance number and birth date. The financial institution uses this information to register your qualifying arrangement and may request additional paperwork such as IDs or licenses.

If you are an independent investor, a self-directed tax-free savings account lets you manage your own portfolio. A self-directed TFSA allows account holders to buy and sell investments on their own terms and according to their preferences.

TFSA Contributions

A TFSA contribution refers to the amount of money you deposit into your tax-free savings account. Unlike other financial accounts, the TFSA has a cap on how much money you can deposit. This limit is called the contribution room.

All contributions to the account during the year count against your allotted contribution room. This includes deposits that replace withdrawal amounts. Should you deposit more money into your TFSA than your remaining contribution room allows, you will face a penalty or tax.

The tax for over-contribution is 1% of the greatest over-contribution amount for the month. As the account holder, you have sole control over TFSA contributions, withdrawals, and investment decisions. 

You can accumulate contribution room before you open a TFSA account so long as you are over 18 and have a valid SIN. You accrue contribution room for every year that you were over 18 since 2009.

TFSA Contribution Room

TFSA Withdrawals

A withdrawal refers to the money you take out of your tax-free savings account. Generally, there are no limits on how much you can withdraw; however, this depends on the type of investment in your TFSA. In addition, qualified transfers from one TFSA to another do not count as withdrawals.

Replacing your withdrawal amounts within the same year will count against your contribution room. For example, if you contribute $5,000 during the year and withdraw $2,000, you cannot replace the full $2,000 within the same year as this will count as over-contribution. Re-contributions that exceed the contribution limit are subject to the 1% tax on the highest excess deposit amount for the month.

How Can You Authorize a Representative?

By authorizing a representative, you give another party permission to access your tax information and report it to the Canada Revenue Agency. An authorized representative can be a spouse, common-law partner, accountant, or tax preparer.

TFSA account holders can authorize a representative through the CRA.

The representative authorization ends when the account holder or the authorized representative cancels the agreement, the authorization reaches an expiration date, or the account holder dies.

Permitted TFSA Investments

TFSA-permitted investments are generally the same as those of a registered retirement savings plan. These investments include cash, mutual funds, bonds, securities, investment certificates, and certain small business shares.

Any losses that affect your original investments are not considered a withdrawal and don’t count against your contribution room.

Account holders can also contribute foreign funds to their tax-free savings account. When contributing foreign funds, it is essential to remember that your TFSA issuer will convert any foreign currency into Canadian dollars. The amount after the currency conversion must not exceed your contribution room; otherwise, you are subject to tax or penalty.

Dividend income paid to your TFSA from a foreign country is subject to foreign withholding tax.

Prohibited TFSA Investments

A prohibited investment is closely associated with the tax-free savings account holder. For example, prohibited TFSA investments can include:

  • Holder debts
  • Interest in a corporation
  • Interest in a trust with a non-arm’s length relationship

Generally, mortgage loans through the Canada Mortgage and Housing Corporation do not count as prohibited investments.

How to Report TFSA Information to the CRA

Your financial institution issuing your tax-free savings account is primarily responsible for reporting your account information to the CRA. TFSA issuers must send a record for every account holder to the Canada Revenue Agency by the end of February each year.

Account holders must review their TFSA statements to confirm that their information is correct. If your issuer’s report contains inaccurate information, you must fill out and send the CRA a revised record as soon as possible.


Group Insurance Policies

Insurance companies are common issuers for tax-free savings accounts. However, many organizations in Canada struggle to find the right insurance policy and carrier for their employees.

From costs to coverage, managers and business owners have several factors to consider when searching for group insurance. With hundreds of options out there, it can seem like an endless challenge trying to narrow down the best and most affordable group insurance policies.

That’s where Group Enroll comes in. Group Enroll is Canada’s premier insurance broker. We help people find the best rates and policies for various types of group insurance, including:

  • Dental Insurance
  • Extended Health Care
  • Life Insurance
  • Disability Insurance
  • Retirement Savings Plans
  • Health Care Spending Accounts

To get started, all you have to do is fill out the quote form to help us gather more information about your specific needs. Then, we source multiple proposals from the top insurance carriers in Canada. Finally, we narrow down the best options for you, so all you have to do is pick from the most competitive offers.

What is a TFSA, and where can you find more information about group insurance? You can email us at hello@groupenroll.ca or find us at 10 Great Gulf Drive, Unit 5, Vaughan, ON, L4K 5W1.