The Finance Industry's Biggest Misnomer: Tax-free Savings Account

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Originally Published on Linked In March 6, 2016. Photo from


If you have a Tax Free Savings Account, otherwise known as a TFSA, you might be earning interest on your money. But are you making the most use of this invaluable tool?


Isn’t it just another type of savings account?


Actually it’s much more than that. TFSAs don’t have to just hold money and pay interest. This is the exact minimum they can do. 


Most investments that have been approved for use in Registered Retirement Savings Plans (RRSP) and Registered Education Savings Plans (RESP) have been approved for use in TFSAs. Stocks, bonds, mutual funds, exchange traded funds and GICs are all able to be held under the shelter of the TFSA. Using these other investment options improves the opportunity to generate a better return than interest in a bank account.


This is why we feel “Tax Free Savings Account” is a misnomer. If you approach investing in your TFSA the same way as your RRSP or your RESP, with a goal(s) and a tax strategy, the TFSA becomes a Registered Tax Free Plan.


The “Tax Free” part is simple. In exchange for not getting a tax deduction when the money is contributed to the account (unlike your RRSP contributions), you get to keep all of the interest, dividends and capital gains you earned in the account TAX FREE. If you need to take money out of your TFSA, you get to add that amount back to your TFSA contribution room for the next year. 


If I don’t get a tax deduction on my contribution, why would I use a TFSA instead of a RRSP?


Flexibility. Making a RRSP contribution is great for offsetting income taxes owed to the government and tax efficient planning for retirement. But all that tax planning can be undone if you need to withdraw from your RRSP for other things.


Tax due on RRSP contributions are not “forgiven” – They are simply deferred until money is withdrawn. The smart tax move is to leave money in your RRSP until your retirement when, presumably, your taxable income is lower. If you take money out of your RRSP in your working years, the amount you withdraw is added to your taxable income for that year and taxed at your highest marginal rate. 


In contrast, no portion of any money you withdraw from your TFSA is taxed. What you take out is what you get.


For example, let’s assume you have a TFSA and a RRSP, both valued at $15,000 and you make $50,000/yr. If you need to withdraw the money from both accounts the amount you would get from your TFSA would be $15,000. The amount you would get from your RRSP would be around $10,500 after income taxes. 


How do I take advantage of my TFSA?


If you won’t be taxed on the interest, dividends or capital gains earned within a TFSA EVER, then it makes more sense to invest using mutual funds, stocks or bonds for longer term financial goals.


Besides, in today’s historically low interest rate environment, a $4,000 balance in a regular savings account won’t pay enough interest to generate a T5 to pay the taxes on that interest. For short term goals and emergency accounts, a regular savings account will serve you well without tax significant tax implications.


See your financial advisor for advice on how to use your TFSA to generate potentially higher returns to help you achieve your long term goals.


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