Canadians love their tax-free savings accounts (TFSA). Since its launch in 2009, more than 60 per cent of us have opened a TFSA. 

And there’s good reason to love them. Gains on investments are never taxed…well, in most cases.

The myth that investment gains are never taxed is one of six popular TFSA myths that could dilute tax savings and even result in penalties from the Canada Revenue Agency (CRA). 

1. Investment gains are never taxed

The “tax free” half of TFSA is a bit misleading.

U.S. dividends generated in a TFSA are subject to a withholding tax on behalf of the Internal Revenue Service (IRS).

That includes the big U.S. blue-chip companies that Canadians love to own. It also includes U.S. mutual funds or exchange traded funds (ETFs), and even Canadian mutual funds and ETFs that hold U.S. equities. 

2. The TFSA is a savings account

Even the “savings account” half of TFSA is misleading.

Since only investment gains are tax exempt, treating your TFSA like a conventional savings account - which generates virtually no interest after fees - is pointless. 

An effective TFSA should hold investments that generate gains such as stocks, mutual funds and exchange traded funds (ETFs).

The spike in interest rates last year has also opened up a world of opportunity in high interest savings accounts and fixed income, which are currently yielding up to five per cent. 

In fact, the tax advantage from fixed income in a TFSA is greater because it would be fully taxed in a non-registered account compared with only half of capital gains from stocks and equity funds. 

3. Contributions are tax deductible

Many Canadians confuse the TFSA with the Registered Retirement Savings Plan (RRSP), which permits contributions to be deducted from your taxable income. 

Returns on TFSA investments are generally tax exempt, but contributions are not. 

4. You can recontribute at any time

Unlike the RRSP, however, TFSA withdrawals can be made at any time without tax consequences. 

Also unlike the RRSP, the allowable contribution space from a TFSA withdrawal is fully restored. 

But if you contribute the maximum amount, the contribution space from a TFSA will not be restored until the following calendar year. 

5. The bank will inform you when you’re maxed out

Many Canadians contribute to their TFSAs through more than one institution and it is the account holder’s responsibility to ensure they don’t exceed their limits. Over-contributions could result in financial penalties.

The CRA provides TFSA limits for individuals on annual tax statements and CRA online accounts but they are usually for the previous year, so be sure to include contributions made in the current year.

The total TFSA contribution limit for anyone over 18 years old was expanded by $6,500 starting Jan. 1, 2023. Accumulated contribution space varies for individuals based on contributions and withdrawals made over the years. 

To get an idea of how significant the TFSA has become, the total allowable amount for those 18 years or older since inception is now $88,000.

6. TFSAs are for short-term goals

The TFSA is generally seen as a short-term savings tool to finance things like a new car, a pool or that big vacation. That can be true, but considering how much the contribution limit has grown, it can also be an effective retirement savings tool to work in conjunction with an RRSP.

RRSP contributions and any gains they generate as investments are fully taxed when they are withdrawn. If those investments grow too much, retirees could be forced to make withdrawals in a higher tax bracket and even face Old Age Security (OAS) clawbacks.

Splitting retirement savings between an RRSP and TFSA allows you to limit RRSP withdrawals to the lowest tax bracket, and top up required funds with non-taxable TFSA withdrawals.