A Tax-Free Savings Account or TFSA is designed to help Canadian citizens save money without undue tax consequences. It is a flexible investment vehicle that is similar to an IRA in the U.S. but allows multiple withdrawals without penalties. A TFSA can help Canadians accomplish short- and long-term investment goals.
How Does A Tax-Free Savings Account Work?
Money invested in a TFSA, whether interest, dividend or capital gains income, is not taxed upon deposit or withdrawal. This allows tax-free compound growth of the money invested in a TFSA that helps investors earn money more quickly than in a taxable account.
Tax-free savings accounts can be set up in any number of ways, and many banks offer deals that remove fees normally associated with managing these accounts. Smart shopping can help potential savers and investors find the right location to open a TFSA.
What Are The Rules of a Tax-Free Savings Account?
A tax-free savings account has an annual contribution limit. For 2013, the limit is $5,500. For the years 2009 to 2012, the limit was $5,000. Every year, the limit is set to rise for inflation by $500.
One of the key advantages of a tax-free savings account that separates it from an IRA in the United States is that a TFSA’s investment “room” can be carried forward indefinitely. Every year, investors will receive a notice from the government of the room they have to invest tax-free in their accounts. This “room” is a compilation of that year’s limit and previous years’ unused amounts, allowing Canadians to make large one-time investments close to retirement or upon inheritance of a large amount of cash.
For example, if you suddenly find yourself with $20,000 to invest and you have not contributed since you opened a TFSA in 2009, you could feasibly invest your entire windfall tax-free. However, this would use your “room” so that any future contributions would be limited to that year’s unused investment limit.
Who Can Open A Tax-Free Savings Account?
Any Canadian resident over the age of 18 with a Social Insurance Number can open a TFSA. However, in Newfoundland, Labrador, New Brunswick, Nova Scotia, British Columbia, the Northwest Territories, Yukon and Nunavut, the age of majority is 19. While contribution “room” begins to accumulate at 18 for residents of these provinces, they must wait until they are 19 to make contributions to their funds.
Unlike an IRA, anyone can make contributions to a TFSA regardless of employment status. There is no requirement for earned income to open or contribute to a TFSA.
Investors do not receive a tax deduction for money contributed to a TFSA. However, all interest, dividends or capital gains are not taxable unless on foreign investments, and all withdrawals are tax-free. Withdrawals can be made at any time, although different banks and other investment organizations have their own rules about fees for withdrawal and limits on withdrawals for particular investment vehicles. Withdrawals become part of the investment “room” of the account and can be re-contributed at a later time, allowing investors to access cash quickly in emergency situations.
Tax-free savings accounts can be traditional savings accounts or may be investments such as stock or bond portfolios. Anyone interested in tax-free savings may want to investigate the benefits of a TFSA.
See Also:
- Five Tips On Savings Accounts
- The Impact of Inflation on Savings
- Savings and Banking
- What are Long Term Investment Accounts?
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Image “Investing 2” by Thomas Picard