Savings Vehicles: Basics of tax free savings accounts

The Canadian government has introduced yet another financial vehicle to help Canadians to save money by reducing taxes on savings. TFSA, a Tax-Free Savings Account is designed to set money aside in eligible investment vehicles and watch those savings grow tax-free throughout their lifetimes. TFSA savings then can be used to purchase a new car, renovate a house, or take a family vacation.

• Starting in 2009, Canadians aged 18 and older can save up to $5,000 every year in a TFSA.
• Contributions to a TFSA will not be deductible for income tax purposes but investment income, including capital gains, earned in a TFSA will not be taxed, even when withdrawn.
• Unused TFSA contribution room can be carried forward to future years.
• You can withdraw funds from the TFSA at any time for any purpose.
• The amount withdrawn can be put back in the TFSA at a later date without reducing your contribution room.
• Neither income earned in a TFSA nor withdrawals will affect your eligibility for federal income-tested benefits and credits.
• Contributions to a spouse’s TFSA will be allowed and TFSA assets can be transferred to a spouse upon death.

TFSA has had a very positive reception amongst Canadians, and for a good reason. Here are some of the benefits you will realize for years to come:

• Tax-Free Investment Income and Withdrawals. Unlike the other registered tax deferral plans, earnings from your Tax Free Savings Account including dividends, and capital gains are NEVER subject to Canadian taxes.
• Flexible Withdrawals. You can withdraw money from your TFSA whenever you want and use that money for multiple purposes. This makes a TFSA ideal for both your short and long-term investment goals.
• No Income Requirement. You don’t need to have earned income to contribute to a TFSA. This is excellent news if you are retired or a stay-at-home parent. Your spouse or common-law partner can give you funds to contribute to your own TFSA. There are no tax consequences to either you or your spouse.
• Indefinite Carry-Forwards. With a Tax-Free Savings Account, unused contribution room is carried forward indefinitely, so you can contribute whenever you have the money. Withdrawals are also added to your unused contribution room starting the following year.
• Investment Choice. You can hold a wide range of investments in your TFSA including stocks, bonds or GICs. This makes the Tax-Free Savings Account appropriate for all types of investors.

No Lifetime Contribution Limits. There is no lifetime limit on the amount of your TFSA contributions. If you are eligible, you will accumulate $5,000 of contribution room every year you are a resident of Canada, which will increase with inflation, in $500 increments.

How is TFSA different from RRSPs? Well, RRSPs are designed to save for retirement, whereas TFSA is meant for saving money that you can withdraw from time to time without incurring a penalty. RRSP contributions are tax-deductable; however, if you withdraw money from your RRSP account, you will be taxed accordingly. The TFSA withdrawals and growth within your TFSA account, however, will be tax-free.

One of the great features of the TFSA is that earnings within the account and withdrawals do not affect income-tested benefits such as the Canada Child Tax Benefit or Guaranteed Income Supplement. While the benefits of a RRSP are debatable for low-income earners, the TFSA will provide the tax deferral benefits of a RRSP without any of the drawbacks.