How residents of Canada can invest tax-free

Newcomers to Canada looking to grow their wealth may want to take advantage of the ability to open a tax-free savings account (TFSA).

A TFSA is a type of investment account people can use to invest without having to pay taxes on their investment income.

Like a Roth IRA in the United States, TFSA contributions are made with after-tax dollars (i.e., contributions are not tax-deductible), but any investment earnings or income within the account, and any future withdrawals, are tax-free.

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Why open a TFSA?

Individuals who take-advantage of the TFSA can significantly reduce the income taxes payable on their investments over their lifetime. Let’s take the following example:

• Martha contributes $7,000 to her TFSA in 2024.
• From 2024-2065, she continues to contribute $7,000 each year.
• Martha earns an average annual compounded return of 6%.

In this example, Martha would receive investment returns of $868,333.78.

If her marginal income tax rate is 30%, Martha will save $260,500.13 in income tax (assuming interest income).

Who can contribute?

Residents of Canada who are 18 years or older and have a valid social insurance number (SIN) can open a TFSA.

It does not matter what form of legal status the individual has in Canada (for example, temporary resident, work/study permit, permanent residence, or citizenship). For the purposes of the TFSA, what matters is whether the individual is considered a resident of Canada for income tax purposes.

How much can someone contribute?

Each resident of Canada accumulates TFSA contribution room for each year they are 18 years old and a resident of Canada. For 2024, the annual contribution limit is $7,000. This contribution limit started at $5,000 in 2009, and is indexed to inflation, rounded to the nearest $500.

Someone who was 18 in 2009 and has lived in Canada since then would have accumulated the maximum contribution room of $95,000.

Individuals can withdraw funds from their TFSA at any time and are not taxed on their withdrawals. The amount they withdraw is added to their contribution room for the following year.

Keeping track of contribution room

If someone exceeds their contribution limit, they face a steep penalty. The Canada Revenue Agency (CRA) taxes them 1% per month on the excess contributions, until all excess contributions have been withdrawn.

For example, if George turns 18 in 2024, and contributes $8,000 dollars to his TFSA, he would exceed his contribution room by $1,000. If George realizes his mistake three months later, and withdraws the $1,000 in excess contributions, he would owe the CRA $30 in taxes ($1,000 x 1% x 3).

Anyone can look up their TFSA contribution limits on their CRA My Account, but these figures might be misleading, for they are normally an entire year out of date. It’s the responsibility of the TFSA holder to keep their own records to ensure that they don’t exceed their contribution limit.

What investments can be held in a TFSA?

The word “savings” in TFSA is something of a misnomer. Although many institutions will allow clients to hold and deposit cash in a TFSA, and some individuals may use this for short-term or medium-term savings, the TFSA is better suited to hold long-term investments, such as exchange traded funds (ETFs), mutual funds, guaranteed investment certificates (GICs), stocks, or bonds.

Individuals will gain a larger benefit from the TFSA when they hold higher-yielding investments inside the account.

Most institutions have similar rules for what can be held in a TFSA as for an RRSP.

What happens if the holder becomes a non-resident of Canada?

If an individual becomes a non-resident of Canada (for example, by moving back to their home country), they can still keep their TFSA, and will not be taxed in Canada on their investment income or their withdrawals.

Individuals will not accrue contribution room for any year throughout which they’re a non-resident of Canada.

If a non-resident makes withdrawals, those withdrawals will still be added to their contribution room for the following year, but they’ll only be able to use this contribution room if they re-establish their Canadian residency.

Individuals should avoid contributing to their TFSAs while they are non-residents of Canada, as any contributions they make as non-residents will be taxed at 1% per month.

How can I find out if I’m a resident of Canada?

Individuals can consult Income Tax Folio: S5-F1-C1: Determining an Individual’s Residence Status.

They can also call the CRA at 1-800-959-8281 (from anywhere in Canada and the United States) or 613-940-8495 (from outside Canada and the United States).

Where can I open a TFSA?

Nearly all Canadian financial institutions who provide investment accounts will allow eligible clients to open a TFSA.

What happens if the holder dies?

TFSA holders can pass on their TFSA to their spouse or common-law partner as a successor holder of the account.

Like the original holder, the successor holder will not be taxed on any earnings or withdrawals from the inherited account.

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