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Investment Tip of the Day
Tax-Free Savings Accounts
Back in 2008 the Ministry of Finance introduced the Tax-Free Savings measure as an investment option for Canadians to save for the future. It is a type of savings account whereby any investment income earned inside the account (including compounding interest) will not be taxed, even when withdrawn.
For Canadian residents of 18 years of age or older with a Tax-Free Savings Accounts (TFSA) one can withdraw money at any time. However, contributions made to it are not tax deductible.
There is a $5,000 annual contribution limit. And any unused TFSA contribution is carried forward and accumulates for the following years. Withdraws cannot be re-contributed without risking over-contribution for that year — one must wait until the following year before the room is made available again (it is reallocated in the tax year following the withdrawal). So, for example, if you’ve contributed $5,000 for the present year into your TFSA and then go about withdrawing the full $5,000 then you cannot re-contribute any more money into this account until the following year.
TFSAs come in a variety of investment flavors including as GICs, bonds, public/private traded shares investment accounts, mutual funds, and many more. The structure of TFSAs are very generous in what it can be used towards in earning tax-free income. And one extra benefit is that income earned doesn’t affect federal credits and benefits like Canada Child Tax Benefit and Old Age Security.
TFSA also allows limited income splitting by allowing higher-earning individuals to contribute to a lower-earning spouses TFSA.
Some may confuse TFSAs with RRSPs. However, in many respects TFSA is the direct opposite of RRSPs. RRSPs are for retirement and TFSA is to be used for everything else. Contributions to RRSPs are tax-deductible and withdraws and investment income are all taxable. Contributions into a TFSA are not tax-deductible but there is no tax on withdraws of investment income earned or contributions to a TFSA. RRSPs also must be withdrawn before the account holder turns 71 in age. TFSAs on the other hand do not expire. Another notable distinction between the two is that any withdraw space made within a TFSA is automatically made available as contribution space again in the following year. Contribution space is permanently lost on RRSPs once a contribution was made and a withdrawn is taken.
TFSAs are similar to Roth IRAs of the United States.