How Canadians Can Invest Tax-Free with a TFSA

For newcomers to Canada looking to grow their wealth, opening a Tax-Free Savings Account (TFSA) is a great option. A TFSA allows you to invest without paying taxes on the income you earn from those investments.

What is a TFSA?

A TFSA is similar to a Roth IRA in the United States. Contributions are made with after-tax dollars, meaning they are not tax-deductible. However, any income or earnings within the account and any withdrawals made in the future are completely tax-free.

Why Should You Open a TFSA?

Using a TFSA can significantly reduce the amount of income tax you pay over your lifetime. For example, if Martha contributes $7,000 annually to her TFSA from 2024 to 2065 and earns an average annual return of 6%, she could earn $868,333.78 in investment returns. If her marginal tax rate is 30%, she would save $260,500.13 in taxes.

Who Can Contribute to a TFSA?

Any Canadian resident who is 18 years or older and has a valid Social Insurance Number (SIN) can open a TFSA. It doesn’t matter what legal status you hold in Canada—temporary resident, work/study permit holder, permanent resident, or citizen—as long as you are considered a resident of Canada for tax purposes.

How Much Can You Contribute?

Every Canadian resident accumulates TFSA contribution room each year after they turn 18. For 2024, the annual contribution limit is $7,000. This limit has been adjusted for inflation since it was introduced at $5,000 in 2009.

If you turned 18 in 2009 and have been living in Canada since then, you could have accumulated a total contribution room of $95,000. You can withdraw funds from your TFSA at any time without being taxed, and the amount you withdraw is added back to your contribution room for the following year.

Keeping Track of Your Contribution Room

If you exceed your contribution limit, you’ll face a penalty. The Canada Revenue Agency (CRA) imposes a 1% tax per month on the excess amount until it’s withdrawn. For example, if George contributes $8,000 to his TFSA in 2024 but his limit is $7,000, he would exceed his limit by $1,000. If he withdraws the excess $1,000 three months later, he would owe $30 in taxes ($1,000 x 1% x 3).

You can check your TFSA contribution limits on your CRA My Account, but keep in mind that these figures may be outdated. It’s important to keep your own records to ensure you don’t exceed your limit.

What Can You Invest in Through a TFSA?

Despite its name, a TFSA can hold more than just savings. You can invest in long-term assets like exchange-traded funds (ETFs), mutual funds, guaranteed investment certificates (GICs), stocks, or bonds. These types of investments typically provide higher returns, maximizing the benefits of a TFSA.

Most financial institutions have similar rules for what can be held in a TFSA as for a Registered Retirement Savings Plan (RRSP).

What Happens If You Become a Non-Resident of Canada?

If you move out of Canada and become a non-resident, you can still keep your TFSA. You won’t be taxed in Canada on any income or withdrawals. However, you won’t earn any new contribution room while you’re a non-resident. If you withdraw funds, the amount will still be added to your contribution room for the following year, but you can only use this room if you return to Canada as a resident.

It’s important to avoid contributing to your TFSA while you’re a non-resident, as these contributions will be taxed at 1% per month.

How Can You Determine Your Residency Status?

To find out if you’re a resident of Canada, you can consult the Income Tax Folio: S5-F1-C1 or call the CRA for assistance.

Where Can You Open a TFSA?

Most Canadian financial institutions that offer investment accounts will allow you to open a TFSA if you’re eligible.

What Happens If the Account Holder Dies?

If a TFSA holder passes away, their spouse or common-law partner can inherit the TFSA as a successor holder. The successor holder will not be taxed on any earnings or withdrawals from the inherited account, just like the original holder.