The tax-free savings account (TFSA) lets you stash extra cash for just about anything – rainy-day savings, a new house or retirement. It can even make a great emergency fund to help you get through the financial cost of any unexpected events life throws your way (like a global pandemic). 

To put it simply, a TFSA lets you save up money without paying any tax on the growth within the account or on withdrawals. Still, since the government introduced the TFSA in 2009, it’s estimated that only around half of Canadians have opened one. Here are of the most common misunderstandings about the TFSA:

1. It’s called a savings account, but can hold just about anything.

From our earliest days, a “savings account” was where money went when they came out of the piggy bank. The name suggests deposits, safety and low rates. But almost any investment you can hold in a registered retirement savings plan (RRSP) can also go into your TFSA. This includes bonds, stocks, mutual funds, exchange-traded funds, options, etc.

Personal finance expert Kelley Keehn is among those who wish the government had chosen a different name for the TFSA. “Many banks and financial institutions advertise a set percentage for their cash TFSAs and it’s very low,” she says. “Canadians see the 2% and think ‘those TFSAs don’t pay much.’ In reality, the TFSA is a savings shelter like an RRSP. And you need to choose the investment that goes within it.”

2. You can re-contribute your TFSA withdrawals — but not until the next year.

In the first years of the TFSA, there were many stories about Canadians accidentally over-contributing. Because of these over-contributions, they faced penalties from the Canada Revenue Agency (CRA). But most problems came from a simple misunderstanding.

Some early owners used the TFSA like a conventional savings account, making frequent withdrawals and deposits. If the total of all deposits exceeded the annual limit, they had over-contributed.

In other words, each time you deposit funds it counts as a contribution. That’s regardless of the total amount in the account. So lets say you deposit $2,000 and then withdraw it and deposit again in the same year. Then you’re considered to have contributed $4,000.

And what if you moved a TFSA from one financial institution to another by withdrawing and then re-depositing? Then you may trigger an accidental over-contribution. Making a transfer avoids that problem.

So what can you do to avoid over-contributing to your TFSA? Don't make more deposits in a calendar year than the annual limit, which is $6,000 in 2020.

So far, the CRA has been forgiving. They’ve waived penalties if you say it was an accident and promise not to do it again. But there’s no guarantee they will continue to do this in the future.

The CRA tells you your annual contribution limit – just like your RRSP limit – on your notice of assessment after processing your tax return. Each year’s contribution limit is the total of three amounts:

3. You can’t lose your TFSA contribution room.

If you’ve never opened a TFSA, you can contribute up to $75,500 today – provided you’ve been over 18 years of age since 2009. 

Here’s a breakdown of the TFSA contribution limits in the past decade:

  • $5,000 for each year from 2009 to 2012;
  • $5,500 for each of 2013 and 2014;
  • $10,000 for 2015;
  • $5,500 for each of 2016, 2017 and 2018; and
  • $6,000 for 2019, 2020 and 2021.

Plus, you never lose contribution room, regardless of your age. (Unless you’re a non-resident of Canada for an entire year, during which time you won’t have contribution room). And speaking of age, you must be at least 18 (and have a valid social insurance number) to open a TFSA.

You may not have money today. But many Canadians will reap a mid-life windfall from an inheritance, downsizing a home, severance or insurance payouts. Putting such proceeds into a TFSA (provided they don’t go over the contribution room) can help shield their future growth from income tax.

“Unused contributions from each year can be carried forward,” notes Krystal Yee, personal finance blogger at Give Me Back My Five Bucks. “And withdrawals will [usually] result in new contribution room.”

Let’s say you withdraw $40,000 from your TFSA this year to put towards the down payment on a home. You’ll have $46,000 in additional contribution room next year (the $40,000 you took out plus another $6,000 for 2020).

4. You can use a TFSA as an emergency fund.

You can use a TFSA for your existing savings, even if they’re relatively modest. As long as you don’t lock the funds into a non-redeemable investment such as a guaranteed investment certificate that can only be redeemed upon maturity, you can access the money at any time. This also makes a TFSA perfect to use as an emergency fund. You’ll have the security of knowing the money will be available if you need it.

5. You don’t have to choose between a TFSA and an RRSP.

There are many clever ways to make the TFSA and RRSP work together to improve your wealth. As a general rule, RRSPs are a good choice for longer-term goals such as retirement. But TFSAs work better for more immediate objectives, such as a house down payment. A TFSA is also a good place to save if you have reached your RRSP contribution limit.

Need help getting started? An advisor can help you figure out which savings options are right for you. Most advisors now offer to meet Clients virtually by video chat. Find an advisor today.

Free Saving for Retirement email series

Sign up to receive our free, Saving for Retirement series in your inbox. Over the next 4 days we’ll help you work out how much you’ll need to save, how you can save it – and what to do with it once you’ve saved it.

Sign up now