TFSA, short for Tax-free Savings Account, allows Canadians, age 18 and over, to set money aside tax-free throughout their lifetime. Each calendar year, you can contribute up to $5,000, any unused TFSA contribution room from the previous year, and the amount you withdrew the year before. As with RRSPs, the term savings implies it’s like a bank savings account, which it is not. You can invest in a variety of investments, such as cash, mutual funds, securities listed on a designated stock exchange, GICs, bonds and certain shares of small business corporations
The main benefit of a TFSA is that all income earned in and withdrawals from a TFSA are generally tax-free. Plus, having a TFSA does not impact federal benefits and credits. It’s a great way to save for short and long-term goals. The only age restriction is that you must be 18 (or age of majority in your province) or older to contribute to a TFSA; there is no upper age limit so you can contribute until you die.
You can have more than one TFSA at any given time, but the total amount you contribute to all your TFSAs cannot be more than your available TFSA contribution room for that year. As the account holder, you are the only person who can contribute to your TFSA.
A TFSA can be useful in certain situations. You have already contributed the maximum to your RRSP for the year or just don’t have any contribution room left. TFSAs can be a good way to save for a vehicle, appliances, down payment on a house, and more. The TFSA can also be used in lieu of or in combination with the RRSP Home Buyers Plan. If you are no longer eligible to contribute to RRSPs, due to your age, you can still contribute to your RRSP.
A TFSA is a good way to save for a rainy day as you can make earnings in it and when you need the funds you can take it out tax-free. The best part of a TFSA is that the money you take out can be put back into the TFSA next year and you still get your $5000 maximum contribution that year too.
For young people just starting out, in a low tax bracket now, expecting to increase earnings and be in a higher tax bracket in a few years. At that time, the TFSAs could be transferred to an RRSP, making the contribution when the tax savings is greater.
Over contributing to your TFSAs will incur a 1% tax of the excess amount. There is no grace room like there is for RRSPs. So, if at any time in a month, you have excess TFSA amount, you are liable to a tax of 1% of your highest excess TFSA amount in that month.
The tax of 1% per month will continue to apply for each month that the excess amount remains in the TFSA. It will continue to apply until whichever of the following happens first:
Interest on money borrowed to make TFSA contributions is not a deductible expense for tax purposes. If you have a choice between borrowing to make a TFSA contribution or borrowing to make another investment, you should always borrow to make the other investment. The interest paid on the investment loan may well qualify for tax deduction and thus offset the cost of borrowing.
The TFSA can be a good vehicle to saving for the future or those expenses that crop up unexpectedly. It shouldn’t be your only retirement savings vehicle and a combination of the TFSA and RRSP can a very good way to save for retirement. Or, use to save in your retirement, too.