The Tax-Free Savings Account (TFSA) is more than just a savings account, even though many Canadians tend to use it as such.
You can also put TFSA cash in investments like stocks, mutual funds, bonds, ETFs, etc.
Compared to a savings account, these assets are riskier. However, they also provide higher returns over the long term (historically) and could help you grow your net worth a lot faster.
While TFSAs tend to remind us of savings you can dip your fingers into whenever you need cash, they are also great tools for saving toward retirement.
This article covers how a TFSA compares to a savings account or HISA.
What is a TFSA?
A TFSA is a registered account that allows you to save or invest and earn returns (interest income, dividends, or capital gains) that are tax-free for life. It can be used to save money for any purpose, including short and long-term goals.
Eligible Canadians aged 18 years or older can contribute to a TFSA even in retirement. This is unlike the RRSP account, which must be converted or closed when you turn 71.
Each year you get a TFSA contribution limit. For 2024, the annual limit is $7,000, and if you have been eligible to contribute to a TFSA since 2009 when it was introduced, you now have a contribution limit of $95,000.
TFSA withdrawals can occur at any time. If you withdraw, you can recontribute the amount in the following year(s) without penalty.
Also, if you cannot contribute the full limit in any year, you can carry forward the unused contribution room indefinitely.
TFSA Investments
A TFSA can hold a variety of investment products, including:
- Stocks
- Mutual funds
- Exchange-Traded Funds (ETFs)
- Bonds
- Guaranteed Investment Certificates (GICs)
- Cash
As mentioned earlier, cash in a TFSA is one of the principal ways Canadians choose to use their TFSA.
To get the most out of your TFSA while holding cash, you should shop around for the best TFSA interest rates.
What is a Savings Account?
A savings account is a type of bank account where you keep money and earn interest while the money remains deposited.
Savings accounts at a bank are generally insured by the Canada Deposit Insurance Corporation (CDIC), while those offered by credit unions are insured by provincial deposit guarantee corporations, e.g. DGCM.
Pros and Cons of a Savings Account
Pros
No Monthly Fee: While you may have to pay a monthly fee for your chequing account, most savings accounts are free.
Safety: They provide safety for your money based on the physical and technological securities put in place by the bank. Deposit insurance also means your savings are safe up to a specific amount if the financial institution becomes insolvent.
For example, CDIC insurance covers up to $100,000 per eligible deposit category. Some credit unions offer deposit guarantees of up to $250,000, and some have unlimited coverage.
Interest Income: You earn interest on the money you deposit, and this grows your account over time. Interest is usually calculated daily and paid out monthly; however, check with your bank as some calculate it differently.
Easy to Access: You can easily withdraw money from your savings account when you need it. This is unlike a GIC, where your funds may be locked in for a specific time frame.
Cons
Savings accounts have some limitations:
Limited Transactions: While it is free to park your funds, service fees may apply when you exceed a specific number of transactions. Some online banks offer savings accounts that include unlimited transactions, including mobile cheque deposits.
Minimum Threshold: Some savings accounts don’t pay interest until your deposit amount exceeds a minimum threshold.
Low-Interest Rates: Savings rates notoriously have been low for a while, which means you are not earning much. In fact, since rates are generally lower than inflation, you could be losing purchasing power.
Some ways to combat this problem include searching for a competitive promotional offer or using a high-interest savings account.
Rates Change: Interest rates on savings accounts usually change when the Bank of Canada changes its key lending rate, causing the banks to adjust their prime rate.
Sometimes, banks also change their savings rates on a ‘whim,’ which means you can’t reliably predict what your money will earn.
Types of Savings Accounts
Depending on its purpose, a savings account can be classified as:
1. Regular Savings Account: This is the traditional savings account that is often automatically opened for customers alongside a chequing account at a bank.
2. High-Interest Savings Account (HISA): This account pays a higher interest than a traditional savings account. They are typically offered by online-only banks and some credit unions. A HISA rate can be up to 100x the rate offered by the big banks.
3. Registered Savings Accounts: These include the TFSA, RRSP, and RESP savings accounts. Registered savings accounts are either tax-free or tax-deferred.
4. Hybrid Savings Account: These accounts combine chequing and savings account features. For example, you may get unlimited free bill payments, preauthorized debits, Interac e-Transfers, mobile cheque deposits, and high-interest rates (e.g. the EQ Bank Notice Saving Account).
5. Joint Savings Accounts: A joint account allows couples or friends to save together in one account. The deposit insurance may be doubled as well.
6. Children or Youth Savings Accounts: These kids’ accounts help them learn the basics of banking without paying fees. They may offer a slightly better interest rate and waive some service fees on transactions.
TFSA vs. Savings Account
A TFSA is a registered tax-free account that can hold many types of investments, including savings. If you prefer to hold cash in your TFSA, you should look for a high-interest TFSA account.
The main difference between a traditional TFSA and a high-interest TFSA is in the rates being offered.
For example, as of today, a big bank TFSA offers 0.75%, while a high-interest TFSA at an online bank offers 3.00% (EQ Bank). This is a lot higher.
A TFSA savings account is appropriate if you are saving for short-term goals, such as a downpayment on a house, wedding, vacation, or emergency fund.
If your financial goal is longer-term, such as retirement savings, you could benefit from potentially higher returns offered by stocks, bonds, and ETF portfolios.
TFSA vs Savings FAQs
Many of the best TFSA interest rates are offered by digital banks such as EQ Bank, Motive Financial, and the online banking arms of credit unions.
Savings accounts held at a CDIC member are generally safe, subject to the $100,000 threshold per eligible category per depositor. The same goes for GICs. There is always an element of investment risk when you invest in stocks or ETFs. That said, your account is protected against insolvency if the investment is a CIPF member.
It helps you save for any financial goal, and your earnings remain tax-free for life.
Related: Bank of Montreal Review.
