Tax Free Savings Accounts (TFSA) Guide

The Tax Free Savings Account (TFSA) was introduced to Canadians in January 2009. It is a registered savings vehicle offering tax free investment income. It can be used as a part of your overall financial plan along with existing registered savings plans such as RRSPs and RESPs.

You can invest up to $5,000 per person per year in a TFSA. A number of different investment vehicles qualify, including high interest savings accounts, GICs, bonds, mutual funds and stocks. All of the money that you earn from that investment (i.e. interest, capital gains, etc) is tax free.

This means that your money can grow in the fund tax free and when you want to withdraw it, that income will also be tax free.

You need to be 18 years of age and a Canadian resident to qualify for a TFSA. The maximum amount that you can invest in any given year is $5,000. If you exceed this limit you will be taxed on the amount that you over contribute.

Unlike other government savings programs such as the Registered Retirement Savings Plan (RRSP) or the Registered Education Savings Plan (RESP), the money in your TFSA can be put towards whatever you'd like. It offers flexibility, allowing you to choose what you want to save for and when you want to access your savings. So whether you're saving up for a really nice holiday, a new car or the budget to redesign your kitchen, a TFSA can make your savings work harder.

Other benefits include:

• If you can't afford to contribute the $5,000 to your TFSA this year, don't worry, the unused contribution will be carried forward and accumulates in future years.
• A number of different investment options are eligible for a TFSA such as high interest savings accounts, GICs, bonds, mutual funds and stocks
• If your spouse our common-law partner doesn't have the money to invest you can invest in a TFSA for them.
• There is no maximum age limit to contribute to TFSAs.

Unlike RRSPs, TFSA contributions are not tax-deductible. The contribution and investment earnings are exempt from tax upon withdrawal. When TFSAs were first launched, there was some confusion around the rules. Many Canadians unintentionally over contributed to their TFSA in 2009. They received a TFSA over-contribution notice from the Canada Revenue Agency, and were handed an additional tax bill. If you invest your maximum $5,000 at the beginning of the year and then withdraw some of that money throughout the year, you cannot top up your investment until the next year.

Also, if you withdraw money from one plan to open another, the deposited amount will be counted twice and could put you over the contribution limit. To avoid this, you need to open the new investment vehicle and then have the money transferred directly to it from your existing plan.

In most cases CRA was good with waving penalties for those who misunderstood the rules in 2009, but as the rules surrounding TFSAs become more known, CRA won't be so lenient. Be sure you don't invest more then the maximum amount in your TFSA.

If, at any time in a calendar month, you exceed the TFSA amount, you will be taxed 1% on the highest excess TFSA amount in that month. Example: James put $5,000 into a TFSA in January of 2009. In April he wanted to buy a used car so he withdrew $4,000. In July, he got a bonus at work for $10,000, so he put the $4,000 that he took out back into his TFSA.

This would be considered an over contribution of $4,000 since July, so he would be taxed $240 ($4,000 * 1% * 6 months).

If James had waited until January 2010 to put back the $4,000 he would not have been taxed anything.

For more information on this, visit the Canada Revenue Agency website.

You can withdraw at anytime. Plus, the full amount of withdrawals can be re-contributed starting the following year, allowing for no loss to your total savings available.

No. The investment income earned within a TFSA and the withdrawals from it will not be added to your overall income. This means that it will not affect eligibility for federal income-tested benefits and credits, such as Old Age Security, and the Canada Child Tax Benefit.

You should always name a successor to your TFSA account in order to ensure that the assets will be easily transferred to your loved ones upon your death. There are some restrictions about who can be named as a successor, a spouse or common-law partner are accepted. Speak with your financial institution for more details.

The Government of Canada has provided a TFSA calculator to help you decide if a TFSA is the right investment vehicle for you.

They also provided the following example on how your investment can grow tax free:

"An individual contributing $200 a month to a TFSA for 20 years (assuming an average annual return of 5.5 percent) will accumulate about $11,045 more in savings than if the investment had been made in a taxable savings vehicle."

Essentially, they are taxed in the opposite order.

Money that you put towards your RRSP is tax deductible. It therefore reduces your income for tax purposes in the year that you contribute. When you withdraw from your RRSP this money is added to your income and taxed at current rates. This allows Canadians to save money on income tax today and when the money is withdrawn in retirement years, chances are it will be taxed at a lower income rate. Money that you put towards your TFSA is NOT tax deductible. When you withdraw from your TFSA this money and the investment income accumulated is tax deductible. So the growth on your investment is sheltered from tax.

Also, there is no maximum age limit to contribute to a TFSA. For an RRSP you are not eligible to contribute after the age of 71. RRSPs and TFSAs are both fantastic investment tools. Speak to a professional about your investment strategy for both.

Here are some things to consider when looking for a TFSA:

• Compare the market to find the investment vehicle with the highest rate of return like a GIC.
• Resist the temptation to dip into your TFSA.
• Make use of missed contributions.

Visit our TFSA Tips for more ways to save.

A country that saves is a more prosperous county. Savings help to increase the funds available for economic investment, hence increasing economic activity and growth.

The government introduced TFSAs to encourage Canadians to save by providing more benefits for saving money.

The Government of Canada website has a lot of valuable information on TFSAs. You can also speak with your bank, credit union or a financial advisor about your personal situation. If you don't have a financial advisor, you can find one through the Financial Advisors Association of Canada.