What Investments Are Allowed in a TFSA and How to Invest Them?

What is a TFSA?

The TFSA lets Canadians over 18 save up to the annual maximum contribution limit, which is $6,500 for 2023, tax-free. Which means, any interest that you earn on that money is tax-free. And you can make withdrawals at any time tax-free. (Did we mention it’s tax-free?) That $6,500 in “contribution room” grows every year starting when you turn 18, even if you haven’t opened an account.

For elder millennials who were 18 when the TFSA came on the scene in 2009, your contribution room is a cool $88,000 (the yearly contribution limit has changed over the years due to inflation).

Pro tip: If you aren’t sure how much contribution room you have, you can check the “CRA My Account” feature on the Canada Revenue Agency (CRA) website.

You can open a TFSA at most banks and credit unions in Canada. Every time you deposit money into your TFSA, your contribution room reduces by that amount. When you take money out, you’ll get the contribution room back next year.

Who should use a TFSA?

If you’re a Canadian over 18 and you want to save money, a TFSA is usually a good choice. That said, here’s when it makes sense to open a TFSA:

• You want to save for a short-term goal: Grow your short-term savings tax-free and get your contribution room back the year after you make your withdrawals.
• You want to save for retirement: Buy stocks, bonds, and Exchange-Traded Funds (ETFs) to grow your retirement savings tax-free and don’t worry about your withdrawals being taxed during retirement. A high contribution limit means your portfolio could grow to a six- or seven-figure sum by retirement age.
• You want to save for a home: Save large sums of money for your future home down payment, watch it grow until you are ready to buy, and then withdraw it tax-free. You’ll get the contribution room back the following year.

If it sounds like the TFSA is good for every type of savings goal—you’re pretty much right. The TFSA is essentially the Frank’s Red Hot of the financial world—it goes with everything.

What are the eligibility criteria to open a TFSA?

Almost anyone in Canada can open a TFSA, but you should still make sure that you answer “yes” to the following questions before you head to your local bank branch to open an account.

• Are you a resident of Canada?
• Do you have a valid SIN?
• Are you over the age of 18?

It’s worth noting: Even if you are a non-resident of Canada (such as someone who stays outside of Canada for more than 183 days in the tax year), you can still make contributions. But you’ll need to pay a one percent tax each month on the money in the account—so it might be best to look elsewhere if that’s your situation.

Which investments can I use in a TFSA?

The beauty of the TFSA is that, unlike the name, it is more than just a savings account. Think of the TFSA as a tax-sheltered basket into which you can put various financial products. If the product is held within the TFSA, it enjoys tax-sheltered status.

Here are some of the common financial products you can have in your TFSA:

Cash:

Putting cash in a TFSA is fast and easy. Just open a TFSA savings account at a bank or credit union. TFSA savings accounts are often called high-interest savings accounts (HISAs) and have interest rates that are slightly higher than regular savings accounts—usually in the low single digits. 

If you’re an existing customer at a financial institution, you should be able to open your account online. Otherwise, you may need to provide additional information (including your SIN) and identification in person or through email. Once your account is open, you can transfer cash from your chequing account to your new TFSA savings account.

Guaranteed Investment Certificates (GICs):

GICs lock in your cash for a set period and reward you with cash back at the end of the term (usually your initial investment plus interest). This is called a guaranteed rate of return. You can buy GICs from most banks and credit unions, and you’ll usually earn a higher interest rate than if you keep your cash in a savings account. Keep in mind that money in a GIC is locked-in—so make sure you won’t need it before the term ends.

Bonds:

Bonds are essentially IOUs from bond issuers (usually governments or large corporations), where you give the issuer money by buying the bond, and they promise to pay you back with interest when the bond matures. You can buy bonds within your TFSA by buying a bond ETF like the iShares Core Canadian Universe Bond Index ETF (XBB) through an online brokerage or the self-directed investment portal of your bank.

Or, if you’re not sure about doing it yourself, don’t be shy and talk to your financial advisor.

Mutual funds:

Mutual funds take your money and pool it with other investor cash to buy stocks and bonds, and the specific mix is chosen and managed by a financial professional. Due to the ability to diversify and be professionally managed, mutual funds are a popular investment choice. In fact, about half of Canadians reported using mutual funds in 2022. But these funds can have a downside—high fees that could eat into your profits.

The most popular way to buy mutual funds is through a financial advisor at your local bank or credit union. When choosing which mutual funds to buy, ask yourself: Am I ok with my investment growing and shrinking? Mutual funds contain stocks, which means the value may go up and down over time. So you should be comfortable taking on a little risk.

Exchange-Traded Funds (ETFs):

An Exchange-Traded Fund (ETF) is a basket of stocks and bonds bundled together as a single fund. Just like stocks, ETFs trade on the stock exchange, and their value goes up and down. You can buy “shares” of an ETF either by opening an account with an online brokerage or by using your bank’s self-directed investment portal.

ETFs can be a good choice because they are highly diversified, which means they are made up of hundreds, if not thousands, of different stocks and bonds. Diversification makes ETFs less risky than buying individual stocks, and you don’t have the additional fees associated with mutual funds.

Stocks:

There are two ways to invest in stocks within your TFSA:

1. Through a financial advisor at a bank or credit union. You can instruct your advisor to buy specific stocks or take their advice on which stocks to choose.
2. Do-it-yourself. Open an account at an online brokerage or through the self-directed portal at your bank, and buy stocks yourself for reduced fees. Don’t forget you’ll also need to decide which stocks will meet your goals and how you’ll manage the natural ups and downs of the stock market.

Which investments aren’t allowed in a TFSA?

There are certain types of investments and activities that aren’t allowed in a TFSA, like property, cryptocurrency, and day trading. (Yes, a big bummer.) Some of these options, like day trading, might be easy to do accidentally. And if you break the rules, you’ll be fined. Here’s what doesn’t belong in your TFSA:

Land/Property:

You can’t own land in your TFSA. If you want to buy a home or property using money from your TFSA, you’ll need to withdraw it and use it for the purchase. That said, if you want to invest in real estate in your TFSA, you can buy shares of ETFs of real estate investment trusts (REITs) which are companies that own apartment buildings, malls, or industrial sites.

Cryptocurrency:

Cryptocurrency enthusiasts will tell you that Bitcoin and Ether are real alternatives to holding Canadian dollars and that cryptocurrency represents a financial system outside of world governments’ control or regulation.

But, unfortunately, cryptocurrency is unregulated in Canada, which means you can’t take advantage of tax sheltering, and you can’t hold actual cryptocurrency in your TFSA. But one loophole is that you can buy cryptocurrency ETFs, like Purpose Bitcoin ETF.

Day Trade Stocks:

Finally, there’s day trading, which is buying and selling stocks within a day, or even a few minutes, to take advantage of daily stock fluctuations. Think Wolf of Wall Street, and you’re on the right track. Unfortunately, while day trading might seem like a cool way to earn money, it’s strictly prohibited in a TFSA.

While day trading isn’t allowed, it’s easy to do by mistake—especially if you aren’t aware of this rule and buy and sell stocks yourself using a discount brokerage. It’s important to remember that if you plan to buy securities yourself within a TFSA, do not day trade!

How to pick the best TFSA investments

There are a large variety of financial products and investments that you can house within the tax-sheltered confines of a TFSA—but how do you choose which investments are suitable for you? 

The answer isn’t simple; it really comes down to your unique needs and personality.

What is your risk tolerance? How soon do you want to use the money? For example, if you frequently worry about losing your contributions or want to access your money within the next five years, choosing investments with guaranteed returns—like cash or GICs—might be a better idea.

Alternatively, if you’re investing for the long term and market fluctuations don’t scare you, the TFSA represents an opportunity to grow a substantial nest egg—completely tax-free.