The Tax Free Savings Account (TFSA) – the Canadian Ministry of Finance’s baby – turns five this year… but don’t expect much of a birthday throw down.
Turns out, even after five years on the market, many Canadians are still struggling with the concept of how to use the account. While 68 per cent of Canadians say they are knowledgeable about TFSAs, what goes into the account and understanding contribution limits are still very much grey areas, according to the Bank of Montreal’s third annual Tax-Free Savings Account report.
Canadians Confused Over Investment Options
The poll found that while 48 per cent of those surveyed had an account (which, by the way, is a 23 per cent rise from 2012), only 11 per cent can identify the types of investments that go in a TFSA and just 19 per cent know the new annual contribution limit.
Further to that, only 52 per cent of Canadians understand how and when TFSA contributions are taxed, just 47 per cent get the rules surrounding how much you can re-contribute after making a withdrawal, and one in 10 TFSA holders have over-contributed since they opened their account.
“Being unaware of some of the specific rules around the TFSA can potentially lead to complications down the road,” cautions Christine Canning, head of Everyday Banking Products for BMO. “For instance, those who over-contribute will be required to pay a tax of one per cent on the amount in excess of the limit. This can really add up, so it’s essential that Canadians stay up to date on the specifics of the account.”
Canadians, it seems, are in a need of a little refresher surrounding TFSA.
Your TFSA Cheat Sheet
As the name suggests, TFSAs are a handy little savings option for Canadians who are 18 or older.
A major plus for the TFSA is that there’s no minimum contribution for opening the account and wiggle room for contributions continue to rise annually.
Since 2009, the maximum amount of contribution per year was $5,000, which was boosted to $5,500 at the start of January 2013. Translation – the allowed sum of contributions as of this year is $31,000
What Goes In There?
As an added enticement, investors pay no income tax on investment returns earned in the account, so you won’t be taxed for funds that are withdrawn.
How TFSAs differ from RRSPs
Simply put, a TFSA is like an RRSP for everyday life. While RRSPs are for retirement, money held in a TFSA can be withdrawn whenever.
Conceivably, if you lived to 100, you could continue to contribute to your TFSA whereas with an RRSP you can’t contribute past 71.
Since RRSPs are taken off your earned income pre-tax you have to pay tax on them but RRSP contributions are tax deductible – you deduct your contribution from the income reported on your tax return.
Boost Your TFSA
Of course, you may be well versed in TFSAs. If that’s so, you might feel like this is old news. So for those who stuck around, here are a few gems to soak some of the potential from your TFSA.
Use it to bolster your retirement savings. Not only can you contribute beyond 71 but since withdrawals from a TFSA aren’t taxed, the funds can be used to supplement your income without impacting your taxable income.
Use it as an emergency fund. The money in your TFSA can be withdrawn in the case of an emergency. The following year, you can put any withdrawals back in.
So if you haven’t taken much time to get to know your new TFSA pal, 2014 might be a good time to start.