Tax Free Savings Account (TFSA) Basics
Tax Free Savings Accounts, also known as TFSAs, are a great savings options for Canadians. The main feature of a TFSA is that all capital gains are non-taxable.
TFSA vs. RRSP
The biggest difference between a TFSA and a RRSP (Registered Retirement Savings Plan) is the type of income used to contribute towards it. Contributions towards a TFSA are after tax income, whereas RRSP contributions are before tax. RRSP contributions are also tax deductible; but the funds are taxed on when withdrawn. TFSA funds are not taxed on once when the funds are withdrawn.
To open a TFSA, you need to meet the following two requirements:
- 18 years of age or order
- Valid Social Insurance Number (SIN)
TFSAs were first introduced to Canada in 2009. You’re eligible to contribute each year’s limit, going back to 2008 or the day you turned 18 (whichever one comes first). The annual TFSA contribution limits are dependent on each year as seen below:
Over contributions (at any time during the year) will result in a penalty of 1% penalty of the highest excess amount. When funds are withdrawn from a TFSA, it cannot be deposited back into the account until the following year. To avoid over contributing, its highly suggested to talk with your financial planner before contributing, to ensure that you’re on the right track, and to avoid any penalties.
TFSAs are flexible in terms of the investments types. According to the Canada Revenue Agency (CRA), the following investments can be held within a TFSA:
- Mutual Funds
- Securities listed on a designed stock exchange
- Guaranteed Investment Certificates (GIC)
- Certain shares of small business corporations
Capital losses made on an investment within a TFSA will not be carried forward (typically losses in a regular investment account are carried forward). Capital losses are also not considered as a ‘withdrawal’ as well. As mentioned in the Millennial Savings Guide, TFSAs could be the perfect designation account for automatic savings.
TFSAs are flexible for literally any investment objective. It’s a great account for all generations, from millennials to baby boomers. The major advantage of having a TFSA is the ability to withdrawal funds without being taxed on. The three major investment objectives are short term, long term, and medium term. Each investment objective has different time frames, and are typically for different purposes, as seen below.
Short-term Investment Objective
- Under a year
- Examples: saving up for purchases such as a car, tuition payment, vacation
Medium-term Investment Objective
- 1 – 3 years
- Examples: saving up for a down payment on a house, tuition payment, renovations
Long-term Investment Objective
- Greater than 3 years
- Examples: saving up for retirement, down payment on a house, kids education
TFSAs are a great solution that offers the flexibility of parking your money in an investment account, without the hassle of worrying about taxes. Like every other investment accounts, TFSAs have its pros and cons. The major con is the investing limits. However, the advantage of not being taxed on capital gains outweigh the cons.
Writer: Jelani Smith
Disclaimer: All investing can potentially be risky. Investing or borrowing can lead into financial losses. All content on Bay Street Blog are solely for educational purposes. All other information are obtained from credible and authoritative references. Bay Street Blog is not responsible for any financial losses from the information provided. When investing or borrowing, always consult with an industry professional.