What is a Tax Free Savings Account?
Tax-free? Is there such a thing? Apparently, there is.
A Tax-Free Savings Account (TFSA) is a registered general-purpose savings vehicle with one goal in mind – to help you meet your long-term savings goals. The accounts are flexible, and allow you to earn tax-free investment income. Not only that, but they complement other savings plans, such as RRSPs and RESPs.
How do they work?
All Canadian residents who are 18 years of age or older can contribute up to $5,000 per calendar year to their TFSA and the income they earn is tax-free. Money withdrawn from a TFSA is also tax-free.
You can choose from a wide variety of investment options, including mutual funds, Guaranteed Investment Certificates (GICs) and government bonds.
The Pros
What’s amazing about TFSA accounts is that unused contribution room can be carried forward – and accumulates – in the following years. Not only that, but whatever you withdraw can be re-contributed to the TFSA in future years. You shouldn’t, however, re-contribute in the same year, since it could result in an over-contribution amount. Over-contributions are subject to a penalty tax.
Income earned from a TFSA does not affect your eligibility for federal income-tested benefits and credits, including Old Age Security, the Guaranteed Income Supplement, and the Canada Child Tax Benefit.
Funds can be transferred or given to a spouse or common-law partner so that they may invest in their own TFSA. You can also designate a beneiciary for your TFSA to ensure that your assets will be left to your family member.
Contributions can be made at your convenience, or set up as automatic deposits.
And as if all of these reasons weren’t enough to make you run to your bank and get your own TFSA, 9 times out of 10 the TFSA has the most attractive interest rate across the savings account product line-up.
The Cons
Unlike RRSPs, TFSA contributions are not tax-deductible. Which means that you won’t see the tax benefit in the year you contribute (like a RRSP); the tax benefit comes years later when you withdraw the money.
When the TFSA was first introduced in 2009, a lot of people got burned by over contributing in a given year. If, at any time in a calendar month, you exceed the TFSA contribution amount, you will be taxed 1% on the highest excess TFSA amount in that month.
For example, if you put $5,000 into a TFSA on January 1st of 2010 and in April you want to buy a used car so you withdraw $4,000 from the account, you can’t pay back the $4,000 until January 2011.
If you try to put it back into the account early, you will be over contributing $4,000 which will be charged at 1% for the number of months remaining in the year.
For more information on this, visit the Canada Revenue Agency website.
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