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Okay, so you’ve decided it’s time to start saving some money and you are wondering if putting money into a TFSA will earn you interest.
Investments held within your TFSA can earn you interest if you invest your money into interest generating investments such as GICs, bonds or money market funds. You can also save money in TFSA savings accounts which are basically the same as normal savings accounts but your interest income is tax-free.
It’s important to note that a TFSA investment account is not an investment in itself, but more so like a bucket to hold eligible investments, such as those listed above.
If you don’t already have a TFSA, I’d recommend opening one up with Wealthsimple for the 9 reasons discussed in this article.
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Types of TFSA Investments that Earn Interest
Here is a list of the most commonly used qualified TFSA investments that generate interest income.
- Guaranteed Income Certificates (GICs)
- Bonds (Government or Corporate)
- Savings Accounts
- Money Market Funds
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1.Guaranteed Investment Certificate (GIC)
A GIC operates very similarly to a savings account (secured by CDIC) but they will usually earn you more interest. The main difference is that unlike a savings account, GICs are usually issued for terms anywhere from three months to five years.
The downside of a GIC is the potential penalty or transaction fee incurred for withdrawing your investment before its term expires.
If you are a little confused by this, don’t sweat it, investing in a GIC is just you loaning the bank money in return for regular interest payments plus your principal back at maturity.
How Much Interest Can You Earn From GICs?
Well this question depends on a lot of different factors such as what type of account you are holding your GIC in, how long your GIC’s term is and what financial institution you’re doing business with.
RateHub.ca has a tool on their website that allows you to filter to see what GIC rates financial institutions are offering to their clients based on their preferences.
As you can see below, owning a 5-year GIC held within a TFSA will earn you 2.3% a year in interest from Oaken Financial.
Generally speaking, interest rates for a GIC held within a TFSA should land somewhere between a savings account and government or corporate bonds.
Bonds held within your TFSA will generate you interest. Heck, investing in bonds in any type of account will earn you interest!
But what exactly is a bond? Simply put, a bond is a financial product that represents a loan made by an investor to a borrower.
Bond issuers are usually either governments or large corporations looking to raise capital in the form of debt.
If you, the investor, offer to loan money to either a big corporation or government entity then you will receive regular interest payments plus your principal back upon the bond’s maturity date.
I won’t get into the details of bonds in this article, but my article here, The Pros and Cons of Investing in Bonds does a great job explaining everything you need to know about bonds.
How Much Interest Can You Earn From Bonds?
The interest rate you earn on a bond is referred to as the coupon rate.
So for example, if your $1,000 bond earns you $10 per quarter, your bonds coupon rate is 4% as it will earn you $40 per year (4 quarters in a year) and $40 into $1000 equals 4%.
A bond’s coupon rate really depends on many factors such as the length of time until maturity and the likelihood of that bond defaulting.
However, again generally speaking, bonds can yield anywhere from 2%-5%.
Anything higher would likely require a high level of risk, and anything lower might not be worth your investment.
If you want to invest money in your TFSA and generate regular interest income, bonds are a great way to earn more interest than a savings account or GIC while still maintaining relatively low levels of risk.
3. Savings Accounts
We all know what a typical savings account is, but most major financial institutions in Canada offer what’s called a TFSA savings account.
These function basically the same way as a normal savings account which make them very liquid – in other words, you’ll be able to access these funds very easily and very quickly.
However, the downside of saving money in a TFSA savings account is that the interest you earn won’t be very much.
It might be equivalent to some of the institution’s high-interest saving account rates, but even those rates are quite low.
How Much Interest Can You Earn from a Savings Account ?
Interest rates currently seem to range anywhere between .05%- 2%.
Ratehub has a great article where they analyze some of the best TFSA savings accounts in 2020.
For example, as of August 2020, BMO is offering .05% on their TFSA savings account.
Deciding to deposit $10,000 into this account you will only earn you $5 a year in interest…yikes.
You really aren’t receiving any big returns if you choose to go this route, and if you account for inflation you could actually be losing money.
But hey, if you just want to park your money somewhere safe that you can access quickly and easily, this might not be a bad option for you.
Quick Note #1 – Make sure you don’t deposit too much money into your TFSA each year or you will be hit with a 1% penalty tax.
Here is how you can check your TFSA contribution limit.
4. Money Market Funds
Money market funds are mutual funds that invest in interest generating, low risk investments such as Bonds CDs, GICs, T-bills and other cash equivalent securities.
While I don’t usually give advice when it comes to investing, I personally don’t like these funds.
While Money Market funds are very secure just like a TFSA savings account, their returns are dismal when you factor in the expense ratio you have to pay to keep the fund running.
If you’re looking for a low risk investment that will earn you interest within your TFSA, they are easy enough to find, you don’t need a mutual fund manager to do that for you.
How Much Interest Can You Earn from a Money Market Fund?
Again, this number is very dependent on what financial institution you invest with and what specific fund you’ve chosen, but these returns generally range between .1% – 3% after expense fees have been accounted for.
Attached here I have a mutual fund prospectus for Scotiabank’s Series A Money Market Fund.
As you can see from the photo above, I have grabbed a snapshot of the fund’s returns from 2009-2018. The highest return was 1% and the lowest return was .2%.
And this is Scotiabank we are talking about here, one of the big 5 Canadian Banks, they have some of the best fund managers available!
All this to say, what’s the point? You don’t need a “fund manager” to earn these types of returns, just park your money in a TFSA savings account and avoid mutual funds all together.
To conclude, TFSAs can earn you interest.
If you decide to open a TFSA savings account, then you are basically opening another savings account, you won’t be able to invest within this account, but you will receive a return on your savings which is determined by your financial institution interest rate on the account.
If you’d rather open a TFSA investment account, you can still earn interest income by investing in something like a GIC, corporate or government bond or a money market fund.
Finally, it is important to note that unless you have A LOT of money in your TFSA, the interest you earn will likely be quite minimal, so remember to consider other factors such as the liquidity of your investment when deciding what’s right for you.
Hopefully this article sparked your “interest”…. I had to!
How to Open a TFSA with Wealthsimple (4-Step Guide)
If you are interested opening up a TFSA for yourself, check out The Financial Geek’s Step-by-Step Guide on how to do so with Wealthsimple.