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.
To learn about the annual contribution limit for this year, check out our TFSA page.
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. Visit the Canada Revenue Agency website to see the maximum contribution limit over the years.
If you’ve never contributed to a TFSA before, you can contribute the total amount you’ve accumulated in a single year. Provided, of course, that you have the means to do so and are a Canadian resident of legal age 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Amounts withdrawn from the TFSA are tax-free.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The total amount withdrawn from a TFSA in a calendar year will be added to the contribution limit for the following year.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 you withdrew from your TFSA to fund renovations, you'd be able to add it to your maximum contribution limit the following year, along with any unused 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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