Rounding it up
Tax-free Savings Accounts (TFSAs) and regular savings accounts serve different purposes for saving money
Savings accounts are great for shorter-term savings, when you’re less worried about earning extra money through interest and just want to set aside money towards a goal
TFSAs are great for longer-term savings, as investment accounts they help grow your money tax-free
Having both a TFSA and a savings account is a pretty good idea
Savings are important, and that’s something we can all agree on. Putting aside money regularly takes commitment and sacrifice, but it gives you financial security, financial freedom, can reduce stress, and helps you make more money.
Savings can be used for big ticket purchases like trips, cars, and houses. Savings can help get you through an emergency, like losing a job or urgent car repairs. Savings support you during life changes, like launching a business, moving to a new city, and they’re critical for your retirement.
With lots of savings options to choose from, though, it can be difficult to know what’s the best choice for you and your circumstances. Tax-free Savings Accounts (TFSAs) and savings accounts have similar names, but they work quite differently. They can – and should – be used for different purposes.
How should you use a TFSA and savings account? Read on to learn the differences between the two, and when and how you should use each.
What is a savings account?
A savings account is an easy-to-use, easy-to-open bank account you would usually set up alongside your chequing account at a financial institution, like a bank or credit union.
It often makes the most sense to open a savings account at a bank you already use. The benefit here is that you can easily move money between your accounts – from chequing to savings and vice versa – quickly and easily.
Your chequing account is for all your day-to-day spending. Your savings account is where you should set aside any money you don’t need day-to-day, to accumulate funds for emergencies or for a purchase you want to make in the future.
Most savings accounts accrue interest as a percentage of the funds you have in the account. This incentivises you to keep saving, as more savings equals more interest you earn. In fairness, however, in most savings accounts the interest you earn is pretty low.
Some savings accounts accrue higher interest. These are called, unsurprisingly, high interest savings accounts (HISAs). While high interest savings accounts obviously offer more interest on your account holdings, they come with less freedom than a standard savings account – for example, you might be charged for every transaction you make.
Any interest you earn in a regular savings account will need to be reported as income and will be taxed when you file your taxes. In most cases, that won’t be a massive amount. While savings accounts earn interest, that’s not really their major drawcard. The real benefit to a regular savings account is that you have plenty of flexibility to add and withdraw money as you please.
Great for the short-term
With a regular savings account through a financial institution, you can typically pull your money out at any time. This is useful when your savings are being set aside for more immediate purchases (as opposed to longer term savings like retirement, for example).
Savings accounts are great places to put money you plan to spend in the short-to-medium future. Because the interest in savings accounts usually isn’t making you much extra money, they’re useful as holdings accounts – a place to keep money you think you’ll need easy access to. Think of things like saving to buy a car, saving for a vacation, a new computer, a bike, or for some people, saving for a deposit on a house.
They’re useful for short-term savings because you have easy access to your saved funds, and there aren’t any hoops or punishments to consider when pulling out your money – which can be the case with other longer-term investment savings accounts.
What is a TFSA?
A Tax-Free Savings Account (TFSA) is more or less what the name suggests – it’s a savings account that is tax-free. What that means is that (in almost all cases) you don’t pay tax on your contributions, dividends, or interest accrued. Within your TFSA, you can invest your money into investment portfolios, and any money you earn within your TFSA can be pulled out without tax implications.
So, while the name sounds similar to a regular savings account, a TFSA is actually pretty different. Another way to think of it – a better way, perhaps – is that it’s really a tax-free investment account. You can designate the money within your TFSA into any number of investment vehicles – such as stocks, bonds, exchange-traded funds (ETFs), guaranteed investment certificates (CIGs), and mutual funds – and those investments all grow tax-free. Then, when the day comes for you to take money out, there’ll be no tax on the money you’ve earned in that account either.
TFSAs were introduced by the Government in 2009 as a way to encourage Canadians to save. Anyone over the age of 18 with a social insurance number (SIN) can open one, and most banks offer them.
There are limits to how much you can put into your TFSAs, though. Every year has a contribution limit. However, the limits are cumulative – so everyone has the same opportunity to add to their TFSAs, no matter when they start.
Contribution limits by year
2010 – $5,000
2011 – $5,000
2012 – $5,000
2013 – $5,500
2014 – $5,000
2015 – $10,000
2016 – $5,500
2018 – $5,500
2019 – $6,000
2020 – $6,000
2021 – $6,000
2022 – $6,000
Unused contributions roll over, and any money you take out of your TFSA can be added back in subsequent years. Here are three examples for how this works.
Example 1: if you have never contributed to a TFSA before, you’re able to add a total of $81,500 in 2022. Obviously, that is not possible for most people. But it means that if you’re just getting started with a TFSA and you happen to have some extra money this year – perhaps from a bonus at work or an inheritance – you have more wiggle room than just the $6,000 limit for the year.
Example 2: if you had contributed $30,000 between 2009-2021, you would be allowed to contribute $51,500 in 2022. Example 3: if you had contributed every dollar you were allowed from 2009-2021, which would be $75,500, but you also took out $10,000 in 2021, you would be able to contribute $16,000 in 2022.
You need to be careful not to contribute more than the limits allow. The punishment for over-contributing (putting more in than you are allowed) is a penalty of 1% per month on the excess money you’ve put in. This applies even if your over-contribution is an accident.
For the long-term
TFSAs are most useful as investment accounts. Investments, in general, give you the best returns over the long run and can provide much higher returns than simple savings accounts. So, an investment account will serve you best over a longer stretch of time. The beauty of the TFSA is that, in most cases, any money you earn through your investments is tax-free – because you already paid tax on your money when you earned it before adding it to your TFSA, you won’t pay tax on it again when you pull it out. As longer-term savings (investment) accounts, TFSAs are a great tool to help you save towards retirement.
While TFSAs are almost always tax-free, there are a few exceptions. You may be charged non-resident withholding tax on earnings within your TFSA for any investments in United States stocks and ETFs. You’ll also be charged tax on contributions you make to your TFSA if you add money to your account in years where you are considered a non-resident of Canada (for example, in years where you live outside Canada for most of the tax year).
Which savings vehicle is right for me?
Like most personal finance questions, the answer is: it depends! It depends on your short- and long-term goals and what you need your savings for.
A regular savings account is great for shorter-term saving. They’re ideal for emergency funds, and saving for more immediate needs. They can be readily accessed and have no contribution limitations.
A TFSA account is great for longer-term saving. While there is a limit on what you can contribute, you can use the funds within your account to invest, so you’re able to earn even more money tax-free.
When it comes to TFSAs vs savings accounts, it shouldn’t be a case of choosing one or the other. You can – and probably should – have both. Both a TFSA and a savings account have their purposes. Having both in your financial portfolio is a pretty good idea. One gives you savings freedom in the short term, the other gives you more potential for savings growth in the long term.
Sam Boyer spends, invests, budgets, and writes. He enjoys writing about things he wishes he’d learned earlier — like spending, investing, and budgeting. A journalist originally from New Zealand, Sam has written extensively about consumer affairs, insurance, travel, health, and crime.