Not All Tax-Free Accounts Are Created Equally

Scott McEachern |

Actual Story #1

Bank Teller: I see that you don’t have a Tax Free Savings Account with us, would you like to open one?
Me: No thanks, I’ve got one at another institution.
Bank Teller: Well that’s not necessary, all Tax Free Savings Accounts earn the same amount of interest.
Me: …
Me: Actually, that’s completely false information.

I went on to explain to her how TFSAs work.

Actual Story #2

Prospect: I have some money in a Tax Free Savings Account.
Me: Do you know the interest rate you are earning? Or is it tied to the market?
Prospect: I have no idea, I just thought all Tax Free Savings Accounts earned the same interest.


It is one thing to hear this response from a prospect, but to hear it from a bank teller, who is spreading the (incorrect) news to the masses – it drives me bonkers! After having two of these experiences in a short period of time, it’s led me to write about it.

Tax Free Savings Accounts do not all earn the same amount of interest.

The Tax Free Savings Account (TFSA) is merely a place to hold investments, much like an RRSP. The difference, and what makes each investment vehicle unique, is the tax-treatment of the investments inside of an RRSP or TFSA. I’m just going to be focusing on the TFSA today.

What is a Tax Free Savings Account?

This is what confuses people the most – the name. They hear the word “savings” and they automatically think of a bank savings account. You know, the ones where you might earn a penny or two on a monthly basis because interest rates are so low. That’s actually called a “daily interest” account.

A TFSA is a like a bucket for your investments and there are rules for the bucket. You fund it with after-tax dollars, and as investments grow, you are never taxed on that growth. In addition, you are not taxed when you decide to withdraw any money. It's one of the few gifts the government gives us that we'll never pay tax on!

Having said that, you want investments that have the potential to grow the most inside your TFSA because you don’t have to pay tax on the growth! This is likely an investment that is tied to the market.

There are two scenarios where I feel being invested in a daily interest rate in a TFSA is appropriate. The first scenario is when someone is saving for down payment of a house, where they want to make sure their investments are not going to go down in value and they’ll use the money in the very near future. The second scenario is for an emergency fund, for the same reasons above, but only if you have extra contribution room in the account. Even in both of these scenarios, different institutions pay different interest rates, so make sure to shop around at banks, credit unions, and online banks to find the best rates.

Each year, since its inception, you are allowed to contribute to a certain limit. The CRA website goes into great detail on TFSA limits and technical rules here. You can check your personal contribution room limit on your personal page on the CRA website.

The intent of this blog post is to bring to your attention that Tax Free Savings Accounts do not all earn the same amount of interest. As with everything in finance, TFSAs can be used best after reviewing your personal situation and your goals with a financial advisor. If you are not sure what is in your TFSA - our door is always open to review it with you.