Tax Free Savings Accounts
The Tax-Free Savings Account (TFSA) is a flexible, registered account that allows Canadians to grow their investments, including interest income, dividend payments and capital gains, tax-free. Whereas an RRSP is intended for retirement, the TFSA can be effective for achieving pre-retirement, retirement and estate planning goals and also an emergency fund. TFSAs provide you with a great way to save, tax-sheltered, for any financial goal, whether it’s for a long-term goal like your retirement, or short-term like that dream vacation or a new family car
Unlike the RRSP system where contribution room is completely exhausted as it is used, any amounts withdrawn from your TFSA in a particular year are automatically added to your TFSA contribution room for the following year (and again may be carried forward indefinitely). Fitting with the flexible nature of the account, this will allow individuals to re-contribute an equivalent amount in a future year.
- Funding using after-tax money
Unlike RRSPs but similar to RESPs and the recently introduced Registered Disability Savings Plans (RDSPs), contributions to a TFSA are after-tax funds, which is to say that those contributions are not tax deductible from income.
- Tax-sheltering within the plan
Whether the chosen investment within the TFSA earns interest income, dividend payments or capital gains, there is no tax to be paid on those earnings.
- Withdrawals are not Taxable
Whereas RRSP or RRIF withdrawals are fully taxable, there is no tax paid on TFSA withdrawals. As well, at no time is there a minimum or maximum withdrawal amount, or are there any requirements or restrictions on what you do with those withdrawals. And remember: any withdrawals actually taken will cause a dollar-for-dollar recovery of contribution room to be used in the future.
- Investment Options
A TFSA will be allowed to invest in the same broad list of qualified investments permitted for RRSPs, including stocks, bonds and mutual funds.
- Excess Contribution
Just like with RRSPs, any excess contributions beyond the TFSA contribution limit will be taxed at 1% per month.
- Effect on income-tested government benefits
A significant drawback to receiving RRSP-sourced income is that the holder is not only taxed on that income, but those receipts can affect eligibility for income-tested government benefits (such as the Guaranteed Income Supplement or Old Age Security) and tax credits (in particular, the Age Credit, Canada Child Tax Benefit and Goods and Services Credit). In stark contrast, TFSA withdrawals are not income and therefore will not contribute to the loss of those income sources or tax credits.
Key features of a TFSA:
- Tax-free growth.
- Flexibility to contribute and make withdrawals.
- Save for short- or long-term goals.
- No tax on withdrawals.
- Any amount withdrawn can be re-contributed in future years.
- Withdrawals are not considered income as they do not affect your eligibility for income-tested government benefits or tax credits.
- Can hold many of the same investments as RRSPs.