Tax Free Savings Accounts, also known as TFSAs, are a savings tool that help you save money by allowing you to accumulate savings and earn interest tax free. Let’s start demystifying the Tax Free Savings Account and how they can benefit you!
What is a TFSA?
Plain and simple, a TFSA is a type of savings account – with a bonus! Canadians over the age of 18 can open a TFSA and deposit funds, up to a maximum amount each year. These funds, and any interest earned on the account, are tax-free! This means you don’t have to declare the money you make from it on your income tax return, and you can withdraw from it at your convenience, with absolutely no penalty. Also, a TFSA can hold any type of RRSP-eligible investments, including shares, mutual funds and real estate investment trusts.
How Much Can I Contribute?
A TFSA is a great way to save but it does have its limits. Your TFSA contribution cap is made up of three components:
- An annual TFSA contribution limit
- Unused contribution room from the previous calendar year
- Total amount of withdrawals from your TFSA in the previous year
TFSA contributions are monitored very closely, so be careful! Many Canadians have been confused by the rules and have faced penalties as a result. Over-contributors are taxed 1% of the highest excess amount for each month they are in an excess contribution position. However, don’t stress out too much – your banks should keep you in the clear. For example, if you bank with BMO, they have a nice TFSA calculator on their site.
How Do I Use It?
- Invest unallocated income in a TFSA to protect yourself from capital gains tax and reduce the uncertainty that can come with high-risk investments. Because TFSA’s allow you to withdraw money whenever you want, they are perfect for short and long-term investing!
- Consider moving funds from taxable accounts to a TFSA to help your money grow faster. All income earned is tax-free.
- Maxed out your RRSP contribution? Deposit funds into a TFSA instead. Once you have a Registered Retirement Income Fund (RRIF) you’ll be required to withdraw a minimum amount every year. If you don’t use all of these funds, deposit them to your TFSA for withdrawal at any time without penalty.
TFSAs vs. RRSPs
TFSA’s are tax-free. This means that you can contribute up to the maximum limit without any tax implications when you withdraw the funds.
In contrast, contributions to your RRSP are tax-deferred. You’ll eventually pay tax on the contributions and earnings when you withdraw the funds pre-retirement or when you retire and begin to receive your monthly payouts.
You can learn more about what’s the better choice for you here.