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Demystifying the Tax Free Savings Account (TFSA)

No Comments 26 January 2012

Most Canadians have heard of Tax Free Savings Accounts, AKA TFSAs, know they’re a savings tool, and might have seen some news reports about the CRA contacting people who had mistakenly over-contributed. Despite all that, it seems the majority of us still aren’t sure how a TFSA will benefit them. Let’s do some de-mystification!


Let’s start with the basics. What’s a TFSA?

Plain and simple, a TFSA is another type of savings account – with a bonus! Canadians over the age of 18 can open one and deposit funds up to a maximum amount each year. These funds and any interest earned on the account are tax-free (you don’t have to declare the money you’ve made from them on your income tax return) and you can withdraw them at your convenience, with absolutely no penalty. As well, a TFSA can hold any type of RRSP-eligible investment including shares, mutual funds and real estate investment trusts.


How to calculate your maximum TFSA contribution:

A TFSA is a great way to save but it does have its limits. Your TFSA contribution cap is made up of three components:

  1. An annual TFSA contribution limit of $5,000
  2. Unused contribution room from the previous calendar year
  3. Total amount of withdrawals from your TFSA in the previous year


Don’t over-contribute!

TFSA contributions are monitored closely. Over-contributors are taxed 1% of the highest excess amount for each month they are in an excess contribution position. No stress – your banks should keep you in the clear. BMO has a nice TFSA Calculator on their site.


Now that I have a TFSA, how do I use it?

  1. Invest left-over income in a TFSA to protect yourself from capital gains tax and reduce the uncertainty that comes with high-risk investments.
  1. Consider moving funds from taxable accounts to a TFSA to help your money grow faster (see chart below). All income earned is tax-free.
  2. Because TFSA’s allow you to withdraw money whenever you want, they are perfect for short and long-term investing!
  3. Maxed out your RRSP contribution? Start depositing funds into a TFSA instead. And once you have a Registered Retirement Income Fund (RRIF), you’ll be required to withdraw a minimum amount every year. If you don’t use all of these funds, deposit them to your TFSA for withdrawal at any time without penalty.



Of note, contributing to a TFSA doesn’t shelter your current income the way an RRSP does, so you won’t see an immediate tax savings for that year. As such there is no specific TFSA tool in TurboTax similar to our RRSP Optimizer.


For more information, visit the Canada Revenue Agency TFSA page.