What's the Difference Between a TFSA and a HISA?
Comparing the TFSA and a HISA is like comparing apples to oranges. Sure, they both have to do with saving money but that's really where their similarities end. In fact, by not understanding the purpose of each of these products, you could be giving up thousands of dollars in growth opportunity and taxes payable.
Purpose of the TFSA and HISA
The simplest explanation for the purpose of each account is that the HISA is for short-term savings and the TFSA is for long-term savings. Keep this in mind when deciding where to hold your money.
Differences Between TFSA & HISA
Next, it's important to understand the key features and benefits of each account and their differences so that you can choose the account best suited to your specific needs.
Growth in a HISA is taxable each year (you’ll receive a T5 for interest earned January 1- December 31), however, presumably the amount will be fairly low since the interest rate offered is generally low. Don’t sweat this amount too much. Taxes are inevitable and you’ll still be ahead in terms of growth.
Growth in a TFSA is earned tax-free, forever. This means you’ll never pay tax on growth AND you can let the growth stay in the account to compound and grow even more. This is why it makes sense to hold investments in this account that have potential for significant growth.
A HISA holds cash and the potential growth is limited to the current fixed rate being offered.
A TFSA can hold a variety of investments such as cash (including a HISA), stocks, bonds, GICs, ETFs and mutuals funds. The potential return on this type of diversified portfolio is high. Furthermore, as noted above, all growth is earned tax-free, forever, allowing it to compound and grow quickly.
A HISA has no limit to contributions.
A TFSA is limited to an individual’s contribution room as outlined by the federal government. (If you were 18 in 2009, total contribution room is $81,500 as of 2022). Contribution room is earned each January 1 and any unused room from previous years can also be used. Plus, contribution room can be earned back the following January 1, if a withdrawal is made. This feature makes it a continuous source for tax-free investing and saving.
Notes: Unlike the RRSP, contribution room is not affected by income; everyone gets the same amount of room. Plus, unlike a RRSP, you can contribute beyond age 70, making this an ideal savings account for retirees.
Role in Estate Planning
Upon death, a HISA is considered part of the estate and will be taxed accordingly before it is passed on to any beneficiary named in a will.
A TFSA passes outside of the estate upon death so there are no taxes payable. In addition, if a spouse is named successor holder, they can take over ownership of the deceased's TFSA without affecting their own TFSA contribution room. A named beneficiary can inherit the cash value of the TFSA tax-free, but must close the account.
This estate planning feature makes the TFSA an invaluable tool for not only ensuring more money is left in the hands of loved ones (less tax paid) but that assets are passed on quickly, since waiting for the will to be probated (which can take 3-12 months) isn’t required.
Consider a HISA for Short-Term Savings
If you plan to spend the money you’re saving within the next 3 years, you definitely want to have the cash on hand. Investing that money in the stock market would be too risky as your principal wouldn’t be guaranteed.
A HISA provides a place to safely hold cash with the bonus of earning a little bit of interest. When you need the money for the home down payment, vehicle purchase, vacation, education or otherwise, it will be there.
Another option to consider for short-term savings is a GIC.
Consider a TFSA for Long-Term Savings
If you’re saving for a long-term goal like retirement, then investing in the stock market, which offers the potential for a higher return than a fixed interest rate, is a must. While you do take on more risk, in the long term, history shows that returns are greater than a fixed interest rate.
Holding investments under a TFSA umbrella gives you the added advantage of allowing investments to grow tax-free, leaving more money in your pocket. Plus, there is the HUGE estate planning benefit noted above.
When the TFSA and HISA Go Hand-in-Hand
The HISA is a wonderful tool for short term savings but usually not the best product to hold within the TFSA since growth is limited.
There is an exception to this rule of thumb though. If you happen to have LOTS of TFSA contribution room and no cash to invest at the moment then holding a HISA (for short-term goals) within the TFSA would make sense. After all, there’s no point in paying tax when you don’t have to.
This is common for people in their 20s to 40s who are directing cash flow to rent/mortgage, student loans, car payments, RRSP, company pension, RESP, child care (and more!) and simply don’t have room in their budget for TFSA contributions.
Another option when you have lots of TFSA contribution room is to hold two TFSAs: one for short term savings held in a HISA and one for investing a small, monthly amount to get your TFSA moving in the right direction. In this case, just be sure to TRACK total contributions between the two accounts since if you over contribute, there is a financial penalty.
Last but not least, when you do have some extra cash flow to invest, start moving the HISA out of your TFSA and start moving investments in.
Final Word on TFSAs and HISAs
Both the HISA and the TFSA are essential to everyone’s personal finances. Using these accounts for their correct purpose and saving small amounts, regularly over time, will set you on the path to financial success. If this blog post has you asking more questions, book a Money Questions call with me or email me your questions at email@example.com and I’ll do my best to answer them for you.