Tax Free Savings Account (TFSA)

by Jeffery A. Keill, CFP, CIM, FMA, FCSI, Portfolio Manager, Senior Wealth Advisor Keill & Associates- Advisory Team

What is the Tax Free Savings Account?

The Tax-Free Savings Account (TFSA) was first proposed by the Conservative Government in 2006, but was not introduced in Canada until 2008 as part of the Federal Government’s efforts to encourage saving amongst Canadians. It officially came into use by Canadians on January 1st, 2009. The intention was to fill a gap in various registered savings programs available through the Canadian government. many people had the ability to plan for retirement using Pension Plans or Registered Retirement Savings Plans, but there was a slight gap for those who were unable to utilize either of these.

A TFSA is a type of savings account available in Canada that allows individuals to save and invest money without paying taxes on the income earned within the account or at a future date upon being withdrawn, regardless of its purpose. At first launch it seemed like a small token as a balance of only $5,000 was allowed in the first year. Since that time, the contribution limit has shot up to over $95,000 or $190,000 of tax sheltering on investment income. Even though many Canadians still have not latched onto this important account, it has become a widely used tool for Canadians and their Advisors.

Advantages of a TFSA:

• Tax Benefits: Although you do not get any tax deductions as you would with an RRSP contribution, you do get the sheltering of any interest, dividends, or capital gains earned in a TFSA, even when you withdraw funds. Hence the name “Tax Free Savings Account”. This tax sheltering is an effective way to allow the savings to grow at a greater velocity as there is no tax being paid.

• Contribution Limits: There’s an annual contribution limit, which has and can continue to change from year to year. Unused contribution room can be carried forward to future years. Current contribution limit for 2024 and 2025 is $7,000 and the lifetime contribution limit for 2024 and 2025 can be as much as $95,000 and $102,000, respectively. This upper limit offers tremendous tax savings benefits to many Canadians. It is important to always ensure your limit, as limits reduce as you contribute and is also affected by your age.

• Withdrawals: You can withdraw money at any time without penalty, and the amount you withdraw is added back to your contribution room in the following year. Of course, there are no restrictions on withdrawals from the TFSA.

• Flexibility: TFSA’S can hold a variety of investments, including cash, stocks, bonds, mutual funds, GIC’s, segregated funds, and High Interest Savings Accounts to name the most commonly held types.

• Eligibility: To open a TFSA, you must be a Canadian resident and at least 18 years old. There is no upper age limit, which also makes this a great tool for tax sheltering and efficient wealth transfer upon your death for seniors.

• Contribution Room Carry Forward: If you don’t use your entire contribution limit in a given year, you can carry it forward indefinitely, allowing you to contribute more in future years.

• Suitable for Any Goal: TFSAs are ideal for both short-term goals (like retirement), offering flexibility in how you save.

• No Impact on Government Benefits: Withdrawals from a TFSA do not affect your eligibility for government benefits or credits, making it a great option for low-income individuals.

• Estate Planning Efficiency: Should the TFSA have a beneficiary elected on the account other than the Estate, the result will create a more efficient and less expensive direct transfer to the intended beneficiary. This is because the assets held in the TFSA would be passed to the beneficiary and avoid entanglement in the Estate of the deceased annuitant. Having a beneficiary elected on the TFSA avoids Probate fees and any increased legal fees that would apply on the application or execution of the estate. Further to this, having a beneficiary on your TFSA will allow, more often than not, a quicker distribution to the beneficiary as there is likely no need for court approval  of a Will.

Disadvantages of a Tax Free Savings Account (of which are few but should be kept in mind):

• Contribution Limits: The annual contribution limit can restrict how much you can save tax-free each year. If you have significant savings goals, you might reach the limit quickly.

• Over- Contribution Penalties: If you exceed your contribution limit, you’ll incur a penalty tax of 1% per month on the excess amount until it’s withdrawn, or until the next year’s contribution room is available.

• Non-Deductible Contributions: Contributions to a TFSA are not tax-deductible, meaning you cannot reduce your taxable income in the year you contribute.

• Complexity of Tracking: Keeping Track of your contribution, withdrawals, and unused contribution room can be complex, especially if you have multiple accounts or make frequent transactions. Our Wealth Advisory recommends holding only one TFSA account to limit errors that can have costly fines.

• Limited to Canadian Residents: Only Canadian residents aged 18 and older can open a TFSA, limiting access for non-residents or younger individuals. Future non-residents might also find the tax sheltering of income will not be available on foreign income tax filing.

  
  

Example

In 2023 Barb, a widow now age 73, has $85,000 in a non-registered investment earning 5% interest. This creates a taxable interest income of $4,250. Barb also has a pension as a former teacher of $55,000/year, $15,000 in CPP income, $7,000 in OAS and her required annual RRIF payments are $10,750. Her total income is $92,000. Given this simple information, the amount of tax owing on the ‘unsheltered’ $4,250 interest income, results in about $2,000 to be paid to the government?! If Barb had opened a TFSA and sheltered the $4,250 interest income, the $2,000 tax owing could have been avoided. In other words, by simply opening a TFSA and contributing towards her maximum lifetime contribution limit, she could avoid having to pay this income tax.

Upon Barb’s passing, should she continue to hold the $90,000 non-registered investment, this amount will be added to the value of her Estate and create the requirement for probate that could be an extra $1,000 in Estate Administration Tax in Ontario, and delay the transfer of wealth by months. Having the money in the TFSA with an elected beneficiary would remove this cost and speed up the transfer of wealth.

There are many more examples of how a TFSA can benefit all ages for many financial goals such as educations savings, home buying strategy, retirement income planning, vacation planning, or even testamentary gifting.

Conclusion:

Today, TFSAs are an integral part of Canada’s savings landscape, providing a flexible and tax-efficient way for individuals to save, invest, and manage wealth. If you want to learn more about how to use a Tax Free Savings Account in your own financial plan please contact one of our Wealth Advisors today.

Disclaimer and Notice to Reader:  This Discussion Paper should not be construed as legal or tax advice but rather only as a general statement and explanation of the topic matter.   Professional tax and legal advice should be obtained for the readers own personal situation.  For more information on this topic or how it applies to your family, please contact our Wealth Advisory team. 

Last edit Feb 11, 2025