Finance, Personal

Pros and Cons of TFSA: Read Before Opening a TFSA Account

Since its inception in 2019, TFSA has become a popular investment vehicle with over 70% of Canadians having the account. 

The popularity of TFSA over other registered accounts is based on the fact th at it allows Canadians to save and invest their money without any tax implications on:

  • Savings
  • Interest earned
  • Capital gains
  • Withdrawals

With 90% of TFSA account owners not using their accounts to their full potential, it’s important to understand the pros and cons of this account before signing up.

Here we shall look at the pros and cons of TFSA to help you know what it entails before signing up.

Pros and Cons of TFSA

What is TFSA?

TFSA is an abbreviation for Tax-Free Savings Account (TFSA).

This is a registered account that was introduced in 2009 to allow Canadians to save and invest their money without any taxes.

That’s, interest, dividends, or capital gains earned on a TFSA account are not taxed. 

In addition, your contribution and withdrawal to your TFSA account are 100% tax-free.

This makes the TFSA a flexible savings vehicle that can be used for a variety of purposes, such as saving for a down payment, funding a child’s education, or saving for retirement.

Overall, a TFSA can be a valuable savings tool for Canadians, but it is important to understand the pros and cons of the account before making any investment decisions.

Pros of TFSA

1. All-round Tax Advantage

The tax-free advantage of a TFSA is one of its most significant benefits. 

As noted earlier, any gains or interest earned on a TFSA account are not subject to taxes, allowing your money to grow fast. 

Moreso, your contributions and withdrawals on a TFSA account are completely tax-free.

This can help you maximize your savings and investment goals more quickly and efficiently, as your money grows tax-free.

2. Easy Withdrawals

Unlike other retirement savings vehicles, such as the Registered Retirement Savings Plan (RRSP), there are no restrictions on when or how much you can withdraw from a TFSA. 

This makes a TFSA a great option for those who need a flexible savings vehicle that can be used for emergencies or unexpected expenses.

With a TFSA, you can withdraw funds at any time without penalty. This means that you have immediate access to your money in case of an emergency or unexpected expense. 

Additionally, if you do need to withdraw funds from your TFSA, you can re-contribute the amount you withdrew in the subsequent year without penalty.

3. Carry-Forward Unused Contribution Room

Annually, the government sets the amount you can contribute to your TFSA account.

The general limit for 2023 is $6,500. But if you’re just getting started, you can contribute up to $88,000 in 2023 provided you’re eligible for the account since it started in 2019.

For immigrants, the unused contribution limit starts counting the year you migrated to Canada.

That’s to say that you can contribute any unused contribution room from the previous year. 

In addition, you can contribute any amount you withdraw from your TFSA account in the previous year.

4. Flexible Eligibility

Anyone who is a Canadian resident with SIN and reaches the age of 18 can open a TFSA account, regardless of their income level or employment status.

This means that the account is accessible to a wide range of Canadians, from students and low-income earners to high-net-worth individuals.

Furthermore, a TFSA does not require individuals to have earned income in order to contribute, unlike other retirement savings vehicles such as RRSP.

This means that even those who are not working, such as stay-at-home parents or retirees, can still contribute to a TFSA account and benefit from its tax-free growth.

5. No Expiry Date

Another advantage of TFSA is that it has no expiry date. 

This means that the funds in the account can be saved and invested for an indefinite period. Also, the need to withdraw or close the account becomes unnecessary. 

This is in contrast to other savings vehicles, such as RRSP which have a mandatory withdrawal requirement starting at age 71.

The lack of an expiry date on a TFSA provides Canadians with a flexible and long-term savings option. 

Cons of TFSA

1. Annual Contribution Limit

The annual contribution limit for TFSAs is set by the federal government and can change from year to year. 

While the limit has been steadily increasing since the TFSA was introduced, it is still a finite amount that can restrict your ability to save and invest.

If you exceed the contribution limit, you may be subject to penalties which we shall learn about in the subsequent heading.

In addition, the complexity of what constitutes a TFSA contribution room can serve as a disadvantage as the total limit varies from one individual to the other.

2. Overcontribution Penalty

If you exceed your total TFSA contribution limit, you will be subject to a penalty of 1% per month on the excess amount.

This penalty can add up quickly and eat into the tax-free gains that you have earned on the account.

The overcontribution penalty can be especially problematic for those who have multiple TFSA accounts or who are not keeping track of their contributions.

3. No Tax Refund

Another drawback of TFSA is that it does not provide any tax refunds on contributions, unlike an RRSP. 

When you contribute to an RRSP, you can deduct the contributions from your income, which can result in a tax refund.

This can be a significant benefit for many Canadians, particularly those in higher income tax brackets.

In contrast, there is no tax deduction on TFSA accounts which is a disadvantage for those looking to reduce their taxable income.

Since you don’t get a tax return on TFSA, it means your contribution to the account will not affect your entitled government benefits that are income-tested. This includes:

  • Old Age Security 
  • Guaranteed Income Supplement
  • Canada Child Benefit

4. No Spousal Plan

TFSA doesn’t provide access to a spousal plan. 

A spousal plan allows one spouse to contribute to the retirement savings of their partner, and reduce combined tax.

Because the TFSA does not have a spousal plan, each individual is responsible for contributing to their own account.

This can be a disadvantage for couples who are looking to save for retirement together, as they may not be able to take advantage of the same tax benefits as they would with a spousal plan.

5. Not Investable in All Securities 

One disadvantage of the TFSA is that there are certain prohibited investments that cannot be held within the account. 

The Canada Revenue Agency (CRA) has strict rules around what types of investments can be held in a TFSA, and there are consequences for investing in prohibited assets.

While you can use a TFSA to invest in securities such as include cash, stocks, bonds, mutual funds and index funds, you can’t invest in the following:

  • Options
  • Margin
  • Future contracts
  • Day trading

This can limit the investment options available within the TFSA and may make it less attractive to investors who are looking for more flexibility and a wider range of investment choices.

6. Withholding Tax on Foreign Income

While a TFSA provides tax-free growth on investments within the account, income earned from foreign investments held within the account may be subject to withholding taxes. 

This means that a portion of the income earned may be taken by the government, reducing the overall return on investment.

The amount of withholding tax that is applied can vary depending on the country where the investment is held and the type of income earned. 

For example, the withholding tax on US stocks in Canada is 15%.

It is important to understand the tax implications of investing in foreign markets within a TFSA and to consider the potential impact on investment returns.

7. No Creditor Protection

Another disadvantage of a TFSA is that it does not provide creditor protection, unlike other registered accounts such as RRSPs.

This means that if you owe money to creditors, they may be able to seize the funds in your TFSA in order to pay off your debts.

Although you can mitigate this risk, by having a well-diversified portfolio and not putting all of your savings into a TFSA. 


Should You Open a TFSA Account?

If you are looking for a flexible savings vehicle that allows all-round tax-free growth of your investments and easy withdrawals, then a TFSA may be a good option for you. 

However, if you are looking for a tax deduction on your contributions, or you are saving specifically for retirement, then a Registered Retirement Savings Plan (RRSP) may be a better option for you. 

Ultimately, the decision to open a TFSA account should be based on your individual financial goals and circumstances. 

It is always a good idea to speak with a financial advisor to discuss your options. Ensure that you are making the best decisions for your financial future.

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About John Adebisi

John Adebisi is a CPA, FCCA and MBA holder with a Bachelor's degree in Accounting & Finance. He has over a decade of experience in writing personal and business finance content for audiences across North America, Europe, the UK and Africa. In addition to his writing experience, he also has a strong background in financial research and analysis, giving him a unique perspective of the financial markets. John derives pleasure in helping people make smart financial decisions, and he believes that knowledge and experience can be valuable resources for anyone who wants to learn how to manage their money.

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