How does the Tax Free Savings Account (TFSA) work? What makes it different from an RRSP? Which savings tactic is better for me? There are many questions when it comes to TFSAs and its features remain misunderstood by many Canadians. Here are a few explanations to help you take advantage of this savings account.
The maximum contribution amount for 2016 is $5,500. The Canada Revenue Agency decided that the annual limit would increase with inflation.
A tax amount of 1% per month applies to the excess contribution as long as it remains in the TFSA during the same calendar year. The change of year marks the entry into a new period of contribution therefore the right to contribute for the new fiscal year is renewed.
For example, if you deposited an excess of $1,000 into your TFSA in December 2016, you will have to pay 1% of that amount in taxes ($10 for one month’s excess contribution) as a penalty. In January 2017, this $1,000 will be subtracted from your contribution amount for the new year.
Your unused contribution amounts are added up starting in 2009, when the TFSA was created.
From 2009 to 2012, the annual contribution limit for the TFSA was $5,000. It was raised to $5,500 in 2013 and 2014 before being increased to $10,000 in 2015 and brought back down to $5,500 in 2016.
If you’ve never contributed to a TFSA, you will have accumulated $46,500 of contribution room from 2009 to 2016. You can contribute up to that amount in a single year if you can afford it.
The TFSA is a savings account that can include many types of investments, including guaranteed investment certificates, equities, bonds, mutual funds and exchange-traded funds (ETFs).
Investment income from investment products that you include in your TFSA will grow in a tax-sheltered environment.
Amounts withdrawn from the TFSA are exempt from tax.
This is the big difference between a TFSA and an RRSP. If you withdraw from your RRSP, that amount is added to your annual income and is therefore subject to income taxes.
The total amount withdrawn from the TFSA over a calendar year will be added to the contribution limit for the following year.
For example, if in 2015 you withdrew $5,000 from your TFSA to finance a renovation project, you can contribute up to $10,500 in 2016, plus unused contribution room from previous years.
The TFSA can be used for both. Its main advantage remains the compound return that accumulates over time sheltered from taxes.
According to most financial planners, the RRSP is the best retirement savings plan for the majority of people.
However, if you expect your tax rate to be higher at retirement than it is now (if you are still in school or are temporarily working part-time, for example) it’s better to contribute to a TFSA first.
RRSPs and TFSAs are in fact two complementary savings tools.
Only your survivor (spouse or common-law partner) can be named a successor holder. In the event of your death, that person becomes the new account holder, which remains active.
The new holder may then retain the two separate TFSAs or transfer the value of the account to the TFSA that he or she already held, without reducing his or her own contribution room.
Anyone can be named beneficiary of your TFSA. Upon your death, the TFSA will be closed and the funds it contains will be paid to the beneficiary. The operation is, however, more complex than a simple change of ownership.
No, only individual accounts are allowed.
You can however, open a TFSA in your spouse’s name and contribute in his/her name. For example, a single-income household can double its tax-sheltered savings.
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