5 min read

how does a TFSA work

Written By

Clay Shiffman

A Tax-Free Savings Account (TFSA) is a popular savings vehicle in Canada, designed to help individuals save money while enjoying tax-free growth. Introduced by the Canadian government in 2009, the TFSA provides a flexible and beneficial way to save for various financial goals. Whether planning for a major purchase, an emergency fund, or retirement, understanding how a TFSA works can help you make the most of this valuable financial tool.

What is a TFSA?

A Tax-Free Savings Account (TFSA) is a savings account available to Canadian residents that allows for tax-free growth of investments. The TFSA helps individuals save for various financial goals without the burden of paying taxes on the investment income earned.

It's a versatile and tax-efficient savings tool with many benefits to Canadian residents. Whether saving for short-term goals or looking to grow your wealth over time, a TFSA plays a crucial role in your financial strategy and is a great alternative to a traditional savings account.

TFSA eligibility

To open and contribute to a tax-free savings account in Canada, you must meet the eligibility criteria set by the government.


You must be at least 18 years old. In some provinces and territories where the age of majority is 19, you cannot open a TFSA until you reach the age of majority.


You must be a resident of Canada. Non-residents are not eligible to open a TFSA. However, if you become a non-resident after opening a TFSA, you can maintain your account. Contributions made while you are a non-resident will be subject to a 1% per month penalty tax.

Social Insurance Number (SIN)

You must have a valid Social Insurance Number (SIN). The SIN is a nine-digit number issued to Canadian citizens and residents who want to work in Canada and access government programs and benefits.

Types of tax-free savings accounts

The primary type of tax-free savings account is the Tax-Free Savings Account (TFSA). However, within the TFSA, you have various accounts and investment options to consider based on your financial goals and risk tolerance. Here are some of the different types of TFSAs.


This account functions like a regular savings account but with tax-free interest. It's ideal for those seeking a low-risk, easily accessible place to save money. The interest rates are typically lower, but the funds are highly liquid.

Investment TFSA

An investment TFSA can hold various investment products such as stocks, bonds, mutual funds, ETFs, and GICs. It's suitable for individuals looking for higher returns through market investments and willing to accept more risk. The growth potential is higher, but so is the volatility.


An exchange-traded funds (ETF) TFSA has investment funds traded on stock exchanges. It's ideal for investors looking for low-cost, diversified investment options that are easy to trade. ETFs typically have lower fees than mutual funds and can be traded like stocks.


This TFSA includes guaranteed investment certificates (GICs), which are fixed-term investments with guaranteed returns. It's suitable for individuals seeking low-risk, fixed returns over a specified period. GICs offer guaranteed returns, with various term lengths available, but they usually have lower liquidity.

Self-directed TFSA

This TFSA allows you to choose and manage your investments within the account. It's best for experienced investors who want full control over their investment choices. You can invest in a wide range of assets, including stocks, bonds, mutual funds, ETFs, and more, providing maximum flexibility.

Understanding your TFSA contribution room

The contribution room for your tax-free savings account is the maximum amount you can contribute to your TFSA without incurring penalties. Here’s a detailed look at how it works.

Annual contribution limit

Each year, the Canadian government sets a contribution limit for TFSAs. For instance, the limit for 2024 is $6,500. The annual limit can vary, so it's important to stay updated on the current year's limit.

Accumulation of unused contribution room

If you don't use your full contribution limit in a given year, the unused amount carries forward to future years. Your contribution room increases by that year's limit and is added to your total available room for future contributions.

Lifetime contribution limit

Since the TFSA was introduced in 2009, your total contribution room has accumulated from that year onward. If you have never contributed to a TFSA and have been eligible since 2009, you have accumulated significant contribution room.

Withdrawals and re-contributions

Any amount you withdraw from your TFSA can be re-contributed starting the following year without affecting your contribution room. For example, if you withdraw $5,000 in 2024, you can re-contribute that $5,000 in 2025 in addition to the annual limit for 2025.


Exceeding your TFSA contribution room results in a penalty. The penalty is 1% per month on the excess amount until withdrawn or a new contribution room becomes available. It's essential to track your contributions carefully to avoid this penalty.

Can you withdraw from a TFSA?

Yes, you can withdraw funds from your Tax-Free Savings Account (TFSA) at any time, for any reason, without paying taxes on the withdrawal. Here are some key points to understand about TFSA withdrawals.

Tax-free withdrawals

One of the primary benefits of a TFSA is that withdrawals are completely tax-free. You don't pay taxes on the money you take out, including capital gains earned within the account.

No withdrawal penalties

Unlike some other savings accounts, there are no penalties for withdrawing funds from a TFSA. You can access your money whenever you want without incurring fees or charges.

Re-contribution of withdrawn contributions

When you withdraw money from your TFSA, the amount withdrawn is added back to your contribution room in the following calendar year. You can re-contribute the withdrawn amount later without permanently losing contribution space.

Impact on contribution room

Withdrawals don't affect your contribution room for the current year. For example, if you withdraw $5,000 in 2024, you can re-contribute that $5,000 starting in 2025, in addition to the regular contribution limit for 2025.

Investment options within a TFSA

A tax-free savings account offers a versatile platform for various investment options. This flexibility allows you to tailor your TFSA to match your financial goals, risk tolerance, and investment horizon.


Cash includes money held in a high-interest savings account within your TFSA. It provides high liquidity and safety with guaranteed returns and is ideal for short-term savings or emergency funds. However, cash typically offers lower returns than other investment options.

Guaranteed investment certificates

GICs are fixed-term investments with a guaranteed return over a specified period. They offer low-risk and predictable returns, suitable for conservative investors looking for stability.


Stocks are shares of individual companies that you can buy and sell through your TFSA. They offer the potential for high returns and growth, making them suitable for long-term investors with higher risk tolerance. However, stocks have higher risks due to market volatility and require research and monitoring.


Bonds are debt securities issued by corporations or governments that pay interest over time. They generally carry lower risk than stocks and provide regular interest income, making them suitable for income-focused investors. The trade-off is lower potential returns than stocks, and interest rates can affect bond prices.

Mutual funds

Mutual funds are pooled funds managed by professional portfolio managers, investing in a diversified portfolio of assets. They offer diversification and professional management, ideal for investors seeking a hands-off approach. However, mutual funds come with management fees and may have lower returns than individual stocks.

Exchanged-Traded Funds (ETFs)

ETFs are investment funds traded on stock exchanges, holding a diversified portfolio of assets. They typically have low management fees, offer diversification, and can be easily traded like stocks. ETFs are suitable for cost-conscious investors but still carry market risks similar to stocks.

Real Estate Investment Trusts (REITs)

REITs are companies that own, operate or finance income-generating real estate. They provide exposure to real estate markets with potential for income and growth, making them suitable for diversification. However, they are subject to real estate market risks and economic conditions.


Options are financial derivatives that give you the right, but not the obligation, to buy or sell an asset at a set price. They offer the potential for significant gains with a limited initial investment, which is suitable for experienced investors. However, options are high-risk and complex, making them unsuitable for all investors.

TFSA transfers and beneficiaries

TFSA transfers

Internal transfers

Within a single financial institution, you can transfer funds between different types of TFSAs, such as from a cash TFSA to an investment TFSA, without affecting your contribution room. These transfers are straightforward and typically do not involve any fees.

External transfers

Transferring your TFSA from one financial institution to another is also possible. This process is known as a direct transfer. To avoid affecting your contribution room or incurring penalties, you must use the institution's formal transfer process. Withdrawing funds and redepositing them yourself will count as a new contribution and could result in over-contribution penalties.

Spousal transfers

If your spouse or common-law partner passes away, their TFSA can be transferred to your TFSA without affecting your contribution room. This transfer should be completed within the same calendar year to ensure it remains tax-free.


Naming a beneficiary

You can designate a beneficiary for your TFSA. A beneficiary is the person who will receive the funds in your TFSA upon your death. Naming a beneficiary helps ensure that your assets are distributed according to your wishes and can simplify the transfer process for your heirs.

Successor holder

In some provinces, you can name your spouse or common-law partner as a successor holder. A successor holder takes over the TFSA upon your death, and the account remains a TFSA without affecting their contribution room. This designation is beneficial as it allows the TFSA to continue growing tax-free.

Changing beneficiaries

You can change your beneficiary designation at any time. It is important to review and update your beneficiary information regularly, especially after major life events such as marriage, divorce, or the birth of a child.

Tax implications of a TFSA

Tax-free growth

One of the primary benefits of a TFSA is that any investment income earned within the account, including interest, dividends, and capital gains, is tax-free. Your savings grow faster than taxable accounts where such income would be subject to taxation.

Tax-free withdrawals

You can withdraw funds from your TFSA at any time, for any purpose, without incurring taxes on the withdrawals. This flexibility makes TFSAs ideal for both short-term and long-term savings goals.

Contribution limits

The government sets an annual contribution limit for TFSAs, which can vary from year to year. Exceeding your contribution limit results in a 1% per month penalty tax on the excess amount until it is withdrawn or additional contribution room becomes available in subsequent years.

Unused contribution room

If you do not contribute the maximum amount allowed in a given year, the unused contribution room can be carried forward indefinitely. You can catch up on contributions in future years without penalties.

Investment options

TFSAs can hold different investments, including cash, stocks, bonds, mutual funds, ETFs, and GICs. The tax-free status applies to all types of income generated within the account.

No impact on government benefits

Withdrawals from a TFSA do not affect eligibility for federal income-tested benefits and credits, such as Old Age Security (OAS), Guaranteed Income Supplement (GIS), or the Canada Child Benefit (CCB). This makes TFSAs particularly advantageous for retirees and low-income earners.

Estate planning

Upon your death, the assets in your TFSA can generally be transferred to your spouse's TFSA on a tax-free basis, provided they are named as the successor holder or beneficiary. For non-spousal beneficiaries, the fair market value of the TFSA at the time of death is generally considered taxable income in the year received.

Alternatives to a TFSA

Whether you choose a TFSA vs. a high-interest savings account or other options, it's important to understand their features to make an informed choice that matches your financial strategy.

Registered Retirement Savings Plans (RRSPs)

This is a tax-deferred retirement savings vehicle where contributions are tax-deductible, reducing taxable income in the contribution year. Contributions grow tax-deferred until withdrawal, ideally during retirement when tax rates may be lower. Contributions may also qualify for a tax refund. Withdrawals are taxable, potentially affecting government benefits in retirement.

Non-registered investment accounts

These are standard investment accounts, like a high-interest savings account or traditional savings account, where capital gains are taxable in the year received. There aren't contribution limits or restrictions on withdrawals. However, you pay tax on the investment income, potentially reducing overall returns. You can learn about the different types of savings accounts in Canada to understand which one matches your needs.

Employer-sponsored retirement plans

There are workplace pension plans or Group RRSPs offered by employers, allowing for contributions directly from payroll. The employer may offer contributions, tax-deferred growth, and other automatic savings through payroll deductions.

Education savings plans (RESPs)

RESPs are designed for saving for a child's education, with contributions not tax-deductible but earnings grow tax-deferred until withdrawn for education purposes. Beneficiaries have access to government grants, tax-deferred growth, and flexibility.

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