What is a TFSA?
When it comes to savings, a lot of people have questions. A TFSA vs a high-interest savings account: which one is better? What about a regular savings account vs a TFSA?
First, let’s learn what a TFSA is.
Understanding the TFSA
TFSA stands for Tax-Free Savings Account. You make contributions, you earn interest, and the capital gains in the account will grow tax-free. The money put into a TFSA is an after-tax contribution. That means you’ve already paid taxes on those funds, and you will never be taxed when you eventually withdraw them.
You can open a TFSA for reasons other than retirement. You could have a TFSA to help you save for a house or education.
But when it comes to TFSA vs savings accounts in Canada, there are some differences. And we’re not just referring to high-interest savings accounts vs TFSAs, but also TFSAs vs normal savings accounts as well. Let’s look at what the differences are.
TFSAs Have Contribution Limits
TFSAs have limits to how much you can contribute to them every year. They’re a powerful financial tool, but they’re not designed to house all your savings.
You can determine your TFSA contribution maximum through a fairly straightforward process, the Financial Geek explains. But remember that a limit is there. While it’s a free savings account, a TFSA is not going to be your sole method of savings.
A normal savings account does not have a contribution limit. You’ll want to investigate interest rates, as the interest rates on a savings account could be higher or lower than the interest rate of a TFSA. As with all savings plans and types of investments, it’s important to get things clear up front rather than waste time having your valuable savings in a low-performing account.
There is a Minimum Age Requirement for a TFSA
While even children can start saving their money in a normal savings account, to start a TFSA you need to be 18 years of age or older. Young people who are savvy with their money look forward to when they can open a TFSA. It means a higher rate of return than the average savings account of a school-aged child.
There is also the requirement that TFSAs are only available to Canadian residents, and you need to have a valid Social Insurance Number. While anyone living in Canada can use Canadian banks or credit unions to open savings accounts, only legal Canadian residents are eligible for this program.
You May Not Be Able to Freely Spend Money from Your TFSA
When you have money in a savings account, you generally have a way to access it easily, often with just a debit card. But with a TFSA, there is no mechanism that acts similarly to a chequing account. You can’t simply pay for things with your TFSA directly.
Your TFSA could have an investment term length (1 to 5 years) that prevents you from accessing your money readily. If you know you’ll need access to at least a portion of your funds within a year, there are redeemable investment options for you to consider.
If you choose a non-redeemable/higher interest rate TFSA and you’re ready to buy that house, that car, or pay tuition, you will need to work with your financial institution to transfer the money into a savings account or a chequing account and possibly pay an early redemption penalty. This means that, if you’re looking for an emergency fund, a non-redeemable TFSA might not be the best option for you.
You Don’t Pay Taxes on Your TFSA
Money that you gain through your TFSA, even the growth of investments, is not taxed. On the other hand, you do have to pay taxes on the interest that you gain through a savings account. While this is sometimes overlooked, Canadian tax law states that you must pay taxes on any funds you receive through your savings account.
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