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 is $6,000 for 2020 and for 2021.
According to The Canada Revenue Agency, the annual cap will increase with inflation.
A tax of 1% per month applies to the overcontribution only if it remains in the TFSA in the same calendar year. The change of year marks the entry into a new period of contribution, in other words, the right to continue contributing during the new year.
For example, if you deposited $1,000 in excess in your TFSA in December 2018, you will be required to pay 1% of that amount in taxes ($10 for the month of overcontribution) as a penalty. This $1,000 will be deducted from your contribution room in January 2019. It will no longer be considered excess.
Your unused contribution room accumulates from 2009, when the TFSA was created, to today.
From 2009 to 2012, the annual TFSA contribution limit was $5,000. It was raised to $5,500 in 2013 and 2014, before rising to $10,000 in 2015 and being reduced to $5,500 between 2016 and 2018 and to $6,000 in 2019, 2020 and 2021.
If you have never contributed to a TFSA, you have accumulated $75,500 in contribution room from 2009 to 2021. You can contribute up to this amount in one year, if you can afford it and if you are a Canadian resident who has reached the age of majority with a valid social insurance number.
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Amounts withdrawn from the TFSA are tax-free.
This is the big difference between a TFSA and an RRSP, whose withdrawals are added to your annual income and are, therefore, subject to income tax.
The total amount withdrawn from a TFSA in a calendar year will be added to the contribution limit for the following year.
For example, if in 2018 you withdrew $3,000 from your TFSA to fund renovations, you can contribute up to $9,000 in 2019, 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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