TFSA vs. Roth IRA: What Are the Differences?

Video Script

In this video, I’m going to explain the differences between a TFSA and a Roth IRA and answer the most common questions I get about these two investment tools.

As a Cross-Border Financial Advisor, I help my clients in the US and Canada optimize their investments so that they can live a work-optional lifestyle no matter where they live. And because many of my clients are coming from the US, I often get asked if a Roth IRA is better than a TFSA.

While they have similarities, they also have several differences.

First, let’s go over the differences.

There are three main areas where a Roth IRA differs from a TFSA:

1. Contribution rules

2. Carry forward rules

3. Taxation and Penalties

Let’s talk about Contribution Rules:

Try to think of a Roth IRA and TFSA as buckets. To be allowed to fill these buckets, you need to follow some rules.

1) To contribute to a Roth, you need to have earned income. But if you earn too much, you are no longer eligible to contribute.

2) With a TFSA, starting in 2009, you could automatically earn contribution room each year as long as you were over the age of 18 and a resident of Canada. The contribution room is the amount of money you’re allowed to contribute per year.

Next, let’s go over Carry Forward Rules.

A carry forward rule refers to what happens if you don’t contribute one year. Can you contribute more next year? Or have you lost that contribution room forever?

With a TFSA, the contribution room is carried forward each year. So even if you don’t put any money into a TFSA in one year, you’ve still earned contribution room.

In 2009, when the TFSA was created, Canadians earned $5000 per year of contribution room. Currently, the limit is $6000 per year.

If you haven’t put anything into your TFSA and have been an adult resident of Canada since 2009, you would have $81,500 worth of contribution room as of 2022.

You don’t miss out if you forgot to contribute to your TFSA one year. And you can make your contributions any time of the year.

With a Roth IRA, it is a use it or lose it situation. So if you don’t use the contribution room available in a particular year, you will not be able to carry that room forward to the next year.

Next, there are some differences in the penalties and taxes on Roth IRAs versus TFSAs.

With a Roth IRA, you can face a 10% penalty if you take earnings out and your withdrawal isn’t considered a qualified distribution. 

For a withdrawal to be a qualified distribution, you need to be over the age of 59.5 and have had money in the Roth IRA for at least 5 years.

There are a few exceptions to this rule, such as financial hardship and disability. And this penalty is only if you are taking out earnings. It doesn’t apply to the initial amount you contributed. You do not face a penalty on your contributions as this is after-tax money you put in.

A TFSA is much more flexible. You can take money out at any age, and it doesn’t matter how long you have held the account. You also don’t lose the contribution room on the amount you withdraw.

So if you take out $10,000 one year, the next year, you could add back that same amount.

But what are the similarities between a Roth IRA and a TFSA?

Both accounts are set up by their respective governments to encourage people to save money. A TFSA is set up in Canada, while a Roth IRA is set up in the US.

In both cases, you use money that you’ve already paid tax on to contribute.

As long as you follow the rules, when you withdraw money from either a TFSA or Roth IRA, you won’t have to pay tax on that withdrawal.

Now, before we wrap up this video, I’m going to answer some common questions about Roth IRAs and TFSAs.

Is a 401(k) the same as a TFSA?

My clients sometimes ask if a 401(k) is the same as a TFSA. The quick answer is that no, they’re not the same. ItT is like comparing US apples to Canadian oranges. It would make more se3nse to compare a Roth IRA to a Roth 401(k)

A 401(k) is offered through your employer. And unless you’re using a Roth 401(k), you’ll fund your 401(k) account with BEFORE-TAX dollars. Whereas a TFSA is funded with AFTER-TAX dollars.

In addition, because a 401(k) is a plan offered through your employer, they often match a certain percentage. Each year, you and your employer can contribute a maximum amount set by the IRS.

A TFSA is not set up through your employer. It is set up by the government of Canada, and you can contribute through a financial institution, credit union or insurance company.

Another main difference between a 401(k) and a TFSA is that with a 401(k), you cannot carry forward the contribution room that you don’t use. So if you don’t contribute the maximum amount one year, you’re not allowed to pay extra the next year.

Also, with a TFSA, if you take money out one year, you can top up your TFSA the next year for the amount you withdrew. This is not something you can do with a 401(k).

Is a TFSA good for retirement?

Next, some people wonder if a TFSA is good for retirement.

A TFSA is a great tool for everyone at any stage because it offers so much flexibility. I would typically suggest maxing out your contributions to your TFSA each year because any earnings you withdraw from a TFSA won’t be taxed. This means you keep more money in your pocket, which is always a good thing! Also because the withdrawals aren’t taxable income, they don’t affect the OAS claw back.

Is a Roth IRA better than a TFSA?

Finally, some people moving across the border wonder if a Roth IRA is better than a TFSA.

One is not better than the other. Ideally, I would explore having both of these accounts if you qualify.