Canadians generally know what a Tax Free Savings Account is – they know it is an investment tool used for their savings. The CRA, however, has noted that many Canadians have over-contributed to their TFSA. The vast majority of the Canadians do not completely understand what a Tax Free Savings Account is, and how it can benefit them. We will give you a better understanding of TFSAs.
What is a Tax Free Savings Account?
A Tax Free Savings Account is an investment product used as a savings account – with a bonus – the account grows tax free. At the age of 18 Canadians can register for a Tax Free Savings Account and place funds up to $5,500 each year. The interest produced in the account is tax free. Withdrawals can be made at anytime with no penalty. Furthermore, a Tax Free Savings Account can contain any type of Registered Retirement Savings Plan investment, such as shares, funds and REITs (Real Estate Investment Trusts) and GICs.
Calculating your maximum contribution
A Tax Free Savings Account is a great savings plan, but it has limitations. Contributions have three main components:
a) Annual contribution limit of $5,500.00 each year ($5,500 is new for TFSAs for 2013)
b) Previous calendar year of unused contribution room
c) Withdrawals total from previous calendar year
Over contribution penalties
Contributions are monitored by the CRA. Make sure you are not over contributing to your Tax Free Savings account or a penalty of 1% per month will apply.
Strategies for using the TFSA
a) Exchange funds from taxable investment plans to Tax Free Savings Accounts. Capital grows quicker and all income received is tax free.
b) A combination of short of long term investment options will allow the individual to have funds available for withdrawal whenever they like.
c) Generally put your higher risk investments inside a TFSA when possible, to get the largest possible gain from the tax free status.
Tax Free Savings Account vs. Registered Retirement Savings Plan
Registered Retirement Savings Plans have immediate deductions for contributions from that year’s income, but eventually when you take income from the fund, the income is taxed at your personal rate.
Tax Free Savings Plans have no deduction for contributions for that year’s income but when you pull income out in the future, it is all tax free!