TFSA vs Savings Account: What’s Right For You?

What’s the difference between Savings Accounts and Tax-Free Savings Accounts (TFSAs)? They’re the same, except one is tax-free, right? 

Because they have similar names, many people think they’re the same. However, there’s more to TFSA vs Savings accounts than what the CRA does with them. 

In this article, we will teach you the difference between TFSAs and Savings Accounts to help you understand these two types of accounts and determine which is the best option for you.

 

What is a TFSA, and how does it work?

As its name suggests, a TFSA is a tax-sheltered savings account. In a TFSA, you don’t pay tax on:

• Contributions
• Interest earned
• Dividends
• Capital gains

You can contribute, invest, earn a return, and keep or reinvest it all—nothing to declare on your tax return, nothing to pay. 

TFSAs can hold various investment products, such as stocks, bonds, ETFs, mutual funds, and GICs, which makes them ideal for building an investment portfolio customized to your return and risk profile.

Of course, as with all good things, TFSAs are not without contribution limits. TFSAs are only available for Canadian residents with a Social insurance number and over 18 years of age. They also come with an annual contribution limit. 

The TFSA was introduced in 2009, and contribution limits have varied year to year as follows.

The amount you’re allowed to deposit into a TFSA is called your “contribution room.” Know that any unused contribution room carries over to the next year. So, if you contribute $1,000 in 2019 and $2,000 in 2020, you can contribute up to $15,000 in 2021. 

You get back the contribution room on any withdrawals from your TFSA at the start of the following year. 

You can have as many TFSAs as you want at as many institutions as you want, as long as your total contribution doesn’t exceed the contribution limit. 

To open a TFSA, you must contact your financial institution (bank, credit union, broker, etc.). You can also do so online with your discount brokerage or bank. They will require your SIN and date of birth to register your TFSA.

What if I become a non-resident of Canada?

If you become a non-resident of Canada, no TFSA contribution room will accrue for any year during which you are a non-resident. Non-residents with a SIN can also open and hold TFSAs, but any contribution made while non-resident will be subject to a 1% tax for each month the contribution stays in the account. 

Any withdrawals made during the period that you were a non-resident will be added back to your TFSA contribution room in the following year but will only be available if you reestablish your Canadian residency. 

What is a Savings Account, and how does it work?

A Savings Account is a deposit account that provides its holder with interest. The interest rates on this type of account are relatively low but offer withdrawal flexibility. 

Another advantage is that if you hold your Savings Account at the same institution as your chequing account, you can link them together and possibly use your debit card to pay and withdraw cash directly from your savings account.

Contrary to a TFSA, the main drawback is any interest you earn in a savings account is taxable income. That means you will have to report your capital gains on your tax return and pay taxes on them. Though, again, it’s not much.  

Almost every financial institution offers Savings Accounts with various levels of interest rates. Some institutions also require a minimum balance to waive account fees and/or to pay the maximum interest rate available for the account.

 

Which type of account is right for me?

Savings accounts are suitable for short-term savings goals (like sinking funds) or to hold emergency funds. They’re easy to access and offer low taxable interest. 

For most people, emergency funds should cover expenses between 3 and 6 months. 

However, you may want to hold more or less depending on your situation. For example, if your job situation is unstable, or you’re expecting some expenses (e.g. medical, home repairs, etc.), you may want to keep a bit extra. 

On the other hand, if you have no dependents or high-interest debt, you may want a smaller emergency fund. Work on paying off that high-interest debt. 

TFSAs are great for most situations because you can buy almost any investment product in a TFSA. That means you can make it low risk and liquid, for example, by buying GICs inside your TFSA, or make it a bit more risky and long term by using it to buy stocks or ETFs. 

TFSAs are best for medium to long-term investments and even to complement RRSPs for retirement. 

Because TFSAs are tax-free, try to maximize your profits (within your risk tolerance) to take advantage of compounding non-taxable returns in the long term. 

As for other tax-sheltered accounts (e.g. RRSP, RESP), it is a good idea to max out your contribution room in your TFSA before you start saving or investing in taxable accounts. 

 

The bottom line

Both TFSAs and savings accounts have a place in someone’s overall portfolio. Savings accounts are perfect for holding liquid funds such as emergency funds, while TFSA holders can take advantage of tax-free compounding interest to build medium to long-term wealth.

 

Also read

• Best high interest savings accounts
• Best GIC rates
• How to start investing