TFSAs could be a powerful tool to build your wealth while paying no taxes on investment earnings. In this article, we explain what is a TFSA, how it compares to RRSPs, and how to best use TFSAs to build your wealth.

What Is a TFSA?

The Canadian government introduced Tax-free savings accounts in the 2008 federal budget.

TFSAs are registered savings accounts established with after-tax contributions. This means you cannot deduct your TFSA contributions in your tax return. On the flip side, you don’t pay tax on investment earnings inside the TFSA and withdrawals.

If you withdraw funds from a TFSA, you can contribute the funds in a future year without reducing your contribution room. Withdrawals made from your TFSA in the year will be added back to your TFSA contribution room at the beginning of the following year.

TFSA Contribution Limit

Starting in 2009, anyone at least 18 years of age and a Canadian resident may establish a TFSA. Each eligible individual can contribute up to $5,000 to the TFSA. The contribution limit is indexed annually to the consumer price index and increased in $500 increments. Unlike RRSPs, you don’t need employment income to generate TFSA contribution room.

So a person who was 18 in 2009 and made no contribution should have $81,500 in TFSA contribution room available.

Year	Annual TFSA Contribution Room	Cumulative TFSA Contribution Room
2009	$5,000	$5,000
2010	$5,000	$10,000
2011	$5,000	$15,000
2012	$5,000	$20,000
2013	$5,500	$25,500
2014	$5,500	$31,000
2015	$10,000	$41,000
2016	$5,500	$46,500
2017	$5,500	$52,000
2018	$5,500	$57,500
2019	$6,000	$63,500
2020	$6,000	$69,500
2021	$6,000	$75,500
2022	$6,000	$81,500

You can find your TFSA contribution room on your CRA My Account.

TFSA vs RRSP

TFSAs are almost the mirror opposite of an RRSP. In an RRSP, your contributions are tax-deductible, and you pay tax on withdrawals.

Example

Suppose Tim has $100 to invest at a rate of return of 5%. Tim’s tax rate will always be 30%. Tim is considering investing in a TFSA vs. an RRSP for one year.

• TFSA Investment value in Year 2 = $100 (1-30%) x (1+5%) = $73.50
• RRSP Investment value in Year 2 = $100 x (1+5%) x (1-30%)  = $73.50

Notice how both TFSA and RRSP produced the same results. As long as the tax rate on the day you contribute equals the tax rate when you withdraw, both the RRSP and TFSAs produce the same results:

• TFSA Investment value in Year n = $100 (1-contribution day tax%) x (1+return%)ⁿ
• RRSP Investment value in Year n = $100 x (1+return%)ⁿ x (1- withdrawal day tax%) =

Notice how as long as the contribution day tax% = withdrawal day tax% TFSA and RRSPs produce the same results.

TFSA vs RRSP Comparison

Here are some of the similarities and differences between TFSAs and RRSPs.

TFSA	RRSP
Contributions are not tax-deductible (contributions are made with after-tax dollars).	Contributions are tax-deductible.
Investment earnings inside TFSA are not taxed.	Investment earnings inside RRSP are not taxed.
No age limit to collapse a TFSA.	Mandatory termination of an RRSP when you turn 71.
Withdrawals are not taxed.	Withdrawals are taxed.
Because withdrawals are not included in income, they do not affect access to government benefits like  Canada child tax benefit, the GST credit, the age credit, and OAS.	Because withdrawals are included in income, they affect government benefits like  Canada child tax benefit, the GST credit, the age credit, and OAS.
Restricted investments. For example, cannot invest directly in cryptocurrencies.	Restricted investments. For example, cannot invest directly in cryptocurrencies.
Can use TFSA as security for loans	Cannot use RRSP as security for loans
No equivalent to programs like Home Buyers Plan and Lifelong Learning Plan.	Programs like Home Buyers Plan and Lifelong Learning Plan.
Withdrawals will be added back to your TFSA contribution room at the beginning of the following year.	Withdrawals do not increase your RRSP room. Once you contribute, you lose your room forever.
No need to have “earned income” or salary to generate contribution room.	Need to have “earned income” or salary to generate contribution room.

If you want to learn more about RRSP strategies, read our RRSP Planning For Doctors article.

When Should I Contribute to TFSA vs. RRSP

It makes sense to contribute to TFSA when your tax rate is low based on the above. For many small business owners and incorporated professionals, this would generally be earlier in your career or years you are drawing less salary from your corporation, perhaps in a sabbatical year.

It makes sense to contribute to RRSP when your tax rate is higher. For small business owners and professionals, this would generally be in your prime years. You get bigger tax savings from deducting RRSP contributions. When you withdraw, your tax rate should be much lower (in theory) since you would no longer be practicing in retirement.

If for some reason, you plan to make an RRSP contribution today and withdraw while your tax rate remains the same, you would get the same results under both TFSA and RRSPs. So if you plan to save for living expenses, consider a TFSA instead of an RRSP.

What If I Contribution More than the Limit?

Suppose you contribute more than your TFSA contribution limit. In that case, you will need to pay a penalty tax of 1% per month on the excess contribution until you remove the excess.

What Investments Are Allowed in a TFSA?

You may invest in most arm’s-length RRSP-qualified investments, including mutual funds, publicly traded securities, government and corporate bonds, and guaranteed investment certificates.

You cannot directly hold cryptocurrencies or non-fungible tokens inside TFSAs. As an alternative, you can invest in cryptocurrency-based ETFs or other crypto funds as long as those funds are publically traded.

You may be subject to hefty punitive taxes if you invest in prohibited investments. It’s not worth it.