Three Things Canadians Should Know About the Tax-Free Savings Account

Investing Advice

Happy Canada Day to all our Canadian Mint Users! In honor of the holiday, we thought we’d take a closer look at one of the latest and greatest benefits that you, our northern neighbors, get to enjoy: Tax-free savings accounts! We’ll admit, we’re a little jealous. –MintLife.

The TFSA was introduced to Canadians in 2009 and was one of the most significant savings accounts for Canadians since the introduction of RRSPs back in 1957. Here are three key things you should know about TFSAs.

1. Why should you contribute to a TFSA?

The simple answer is they are TAX-FREE! Unlike the RRSP, there is no tax deduction when you contribute to a TFSA. Despite not getting a deduction, there are some great advantages to the Tax Free Savings Accounts:

  • No tax on any growth. Investments grow TAX-FREE inside the TFSA
  • You can withdraw money anytime . . . TAX-FREE
  • When you pull the money out, you can put it back in (the following year) TAX-FREE
  • In fact, you can keep taking money out and putting it back in, TAX-FREE
  • If you did not contribute to the TFSA in the past, your limit accumulates into future years.
  • You never have to take money out and when you die, money goes to your beneficiaries TAX-FREE.

Does it sound too good to be true? There’s one small catch . . . each Canadian over the age of 18 can only put $5,000 per year into the TFSA since 2009.

2. TFSAs are different than RRSPs

Registered Retirement Savings Plans (RRSP) are really designed to save for retirement. When you buy an RRSP, you get an immediate tax deduction based on your contribution. However, taking money out of the RRSP will trigger tax at your marginal tax rate at the time of withdrawal which make withdrawals ideal in retirement.

There is no deduction when you put money into the TFSA but there is also no tax when you take money out of the TFSA so it can be used as both a spending account as well as a savings account for retirement. The TFSA is more than just a retirement account because it can be used long before retirement with no tax implications. Canadians at any age can benefit from the TFSA.

As mentioned, you can take money out of the TFSA whenever you want and you can put the money back into the TFSA in the future without tax or penalties. When you take money out of the RRSP, not only will you pay tax but you also can’t put it back in unless you have contribution room as it is considered a new contribution.

3. TFSAs have lot of investment flexibility

Another great feature of the TFSA is the investment flexibility. When you open up a TFSA, you can invest in anything you want. You can choose from a wide range of investment options such as mutual funds, stocks, Guaranteed Investment Certificates (GICs), bonds and savings vehicles.

One of the common misconceptions about the TFSA is that many people think it has to be a savings account. It can be used as a savings account and invested in low-risk savings vehicles but a the same time, despite the name, it can also be an investment account.

However you choose to invest the funds, the growth on the investment is tax free. If you invest in a saving account, GIC or a bond that produces interest income, there is not tax on the interest. If you buy a mutual fund that grows from $7000 to $12,000, there is no tax on that growth. If you buy a dividend stock that pays a regular dividend, there is no tax on that dividend.

The Tax Free Savings Account really has universal appeal and can be used by many different people for different purposes. Don’t miss out on the powerful benefits of the TFSA.

Jim Yih is a financial speaker, fee-only advisor and the man behind Retire Happy Blog. For the past 20 years, he has written extensively about retirement, government benefits and personal finance.

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