With a TFSA, you could save up to $5,000 per year without having to pay withholding fees or capital gains taxes.
A tax-free savings account (TFSA) gives Canadians the rare opportunity to make capital gains and earn dividends without having to pay taxes on their returns. In 2009, the Canada Revenue Agency (CRA) created a new program that allows Canadian residents to shelter up to $5,000 a year in investments in a tax-free savings account (TFSA).
Although the TFSA contribution limit has changed over the years (in 2019 it was $6,000), the contribution room accumulates every year just like a Registered Retirement Savings Plan (RRSP). This means any unused room is carried over to subsequent years, allowing you to invest considerable sums of money without having to worry about paying taxes on contributions or earnings.
What is a TFSA?
As the name implies, a TFSA is a savings account that allows individuals to invest in securities and to withdraw cash without having to pay taxes on their contributions or earnings. Canadian residents who are 18 years of age or older can open a TFSA by visiting a financial institution, such as a bank, credit union, trust company or insurance company.
There are three types of TFSAs available to individuals: a deposit, an annuity contract and an arrangement in trust. The type of TFSA you end up with depends on your issuer. Your financial institution will have more information.
Benefits of using a TFSA
- Grow your investments tax free: The biggest benefit of a TFSA is in the title itself; the account allows you to grow your investments and withdraw earnings without having to pay withholding fees or capital gains taxes.
- Retirement planning: In addition to an RRSP, a TFSA can be used to pay income during retirement. This gives individuals another option when saving for retirement.
- Lifelong ownership: Unlike the RRSP, a TFSA doesn’t have to be closed at a certain age.
- Keep your contributions: If you don’t use all of your annual contribution limit, you can carry forward the remaining room indefinitely.
Disadvantages of using a TFSA
- Small contribution limit: Savers who utilize all of their contribution room may find TFSAs limiting in terms of how much they can invest. This is especially the case after 2010, when the TFSA contribution limit was virtually cut in half.
- No tax refund: Unlike with an RRSP, contributing to a TFSA doesn’t reduce taxable income.
How to open a TFSA
Canadian residents who are 18 or older and have a valid social insurance number are eligible to open a TFSA. To open an account, you must contact an eligible financial institution, such as a bank, credit union, trust company or insurance company. They will serve as the issuer of your TFSA.
Once you provide the issuer with your social insurance number and date of birth, you can register a qualifying arrangement as a TFSA and begin contributing right away.
What investments can you put into a TFSA?
The types of investments that can go into a TFSA include the following:
- Mutual funds
- Exchange-traded funds (ETFs)
- Guaranteed income certificates
- Bonds (government and corporate)
How to contribute to a TFSA
You can start contributing to your TFSA as soon as you open up an account. This includes depositing cash as well as purchasing investments. Contributions can be made in lump sums or recurring deposits.
Keep in mind that contribution limits may change in any given year, so it’s important to check the CRA website to learn more about how much you can put into the fund. In 2019, the contribution limit was raised to $6,000 from $5,500 in 2018. The good news is that any unused contribution space can be carried forward indefinitely, so you can maximize savings and investments during your high-income years.
How to make withdrawals from a TFSA
Generally speaking, you can withdraw any amount from your TFSA at any time. Of course, the ease with which you can draw money depends on the liquidity of your holdings. If you have cash holdings, withdrawals are easy. If your money is tied up in investments like stocks, ETFs or bonds, you would need to sell the security or wait for it to reach maturity before you can withdraw the proceeds.
In any case, taking money out of your TFSA has no tax implications. There are no withholding fees and no portion is included in your taxable income.
Frequently asked questions about tax-free savings accounts
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