Tax Free Savings Account (TFSA) and You
By Robert Catalano
The Tax-Free Savings Account (TFSA) was introduced by the Federal Government in the 2008 budget and came into effect in 2009. You are able to use this flexible savings vehicle to save for a variety of your short-term and long term goals without any tax consequences. Let’s explore some of the benefits of this savings vehicle.
What is the Tax Free Savings Account?
The TFSA contains elements of both a registered and non-registered account. It allows Canadians to earn tax-free investment income and capital gains, which may help you reach your financial planning goals more quickly. It can also provide an additional source of tax-efficient savings and may complement existing registered savings plans. You may hold different types of investment such as a deposit account, Guaranteed Investment Certificates (GICs), and mutual funds.
Who can contribute to a TFSA?
All Canadian residents aged 18 and older who have a social insurance number will be able to open a TFSA.
Can I contribute to my spouse or child’s TFSA?
If you gift money to your spouse or adult child to contribute to their TFSA, the income and growth in the account will not be subject to the attribution rules. This could help a lower income spouse or adult child who has little or no earned income to earn tax-free investment income and save for retirement as everyone receives annual contribution.
How much can I contribute?
All eligible Canadian residents will be able to contribute $5,500 (limit was $5000 prior to 2013) to their TFSA every year. Therefore, there is up to $25 500 of eligible TFSA contribution room available.
Tax-free investment income and withdrawals
You will not pay tax on the investment income and capital gains earned inside your TFSA and consequently, you cannot use losses generated in the account to offset other taxable capital gains outside the TFSA. You can withdraw funds from the account for any reason, at any time, although timing may depend on what you invested in – for example non-redeemable GICs may not have matured. Withdrawals will not be included in your taxable income. For this reason, funds accumulating in your TFSA will not have an impact on any income-tested benefits you may be receiving, such as Old Age Security and Employment Insurance, or your entitlement to the age tax credit.
How does a TFSA compare to an RSP?
Here’s a summary of the main differences between these two accounts:
> If you contribute funds to an RSP they are tax-deductible. Funds you contribute to a TFSA are not.
> There are maximum age restrictions on making contributions to an RSP. If you are eligible, you can make contributions to a TFSA from age 18 onwards throughout your lifetime.
> The contribution room available in an RSP is determined according to your eligible earned income. For a TFSA, everyone accrues a defined amount of annual contribution room from age 18 onwards, irrespective of earned income.
> If you make withdrawals from your RSP, they are included in your income for the year in which you made the withdrawal. You will not pay tax on funds you withdraw from a TFSA.
> If you withdraw funds from an RSP you cannot recontribute them unless you generate more contribution room. This is not the case with the TFSA. When you make a withdrawal from your TFSA,
the amount withdrawn is automatically added to your contribution room for the following year. You can recontribute funds you have withdrawn at any time after the year you made the withdrawal.
> Funds withdrawn from your RSP will increase your taxable income for the year of withdrawal and may have an impact on any income-tested benefits or tax credits you may be receiving. In comparison, if you withdraw funds from a TFSA, you are not taxed on them. This means that the withdrawal will not affect your eligibility for income-tested benefits and tax credits.
> You are not required to convert a TFSA to an income-stream at a certain age, as is the case with an RSP.
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