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Many investors prioritize a tax-free savings account, or TFSA, over its considerably older tax-saving cousin, the registered retirement savings plan, or RRSP. While there is no tax deduction for TFSA contributions, nor a mandatory termination date (the RRSP’s is the end of the year in which you turn 71), no tax is payable when you withdraw funds from a TFSA, and your contribution room never goes away. However, a TSFA has a crucial restriction for making withdrawals or contributions near the end of the calendar year.
With a TFSA, you may contribute up to C$7,000 in the 2024 calendar year, plus any unused contribution room from previous years. As with an RRSP, you can carry forward this cumulative amount for future use. For example, if you have never contributed to a TFSA, as of 2017, you can immediately put as much as C$95,000 into an account, assuming you were 18 or over when the program was introduced in 2009. That total is based on annual limits that have been increased over the years. The federal government may increase the annual limit based on the inflation rate. The limit will remain C$7,000 for 2025.
As with RRSPs, income earned within a TFSA is sheltered from tax—though with an RRSP, this is only a deferral, whereas a TFSA provides a permanent tax break. Interest on loans taken out to fund a contribution are not tax-deductible. Eligible investments are mostly the same for TFSAs as they are for RRSPs—stocks and other equity securities, bonds and other fixed-income securities, mutual funds, exchange-traded funds, cash and equivalents, and in some cases, shares of private corporations.
You can also make contributions in kind using eligible securities you already own in other accounts. And at death—as with an RRSP or its post-retirement successor, a registered retirement income fund, or RRIF—the assets within a TFSA can be transferred to your spouse without tax implications, and the spouse’s lifetime contribution room is unaffected.
But that’s where the similarities end. TFSA contributions are not tax-deductible. However, nothing is taxed upon withdrawal, so there’s no heavy tax hit like when you remove capital and income from a TFSA.
What’s more, when you remove capital from a TFSA, your lifetime contribution room is replenished by that amount. So if your current contribution room stands at C$20,000 and you withdraw C$5,000, your cumulative limit will increase to C$25,000.
There is a catch, though. When you withdraw money from a TFSA, you must wait until the following calendar year to put that money back into your account. If you made the maximum contribution during the current year and don’t wait until the new year to replace that money in your TFSA, you will be deemed to have made an excess contribution and be subject to a penalty tax. That penalty is 1% of the excess amount for every month you are offside. (The penalty is based on the highest balance during the month.)
There are some additional restrictions to bear in mind when staying onside with a TFSA:
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar's editorial policies.