A tax-free savings account (TFSA) provides Canadians a way to earn investment income without having to pay tax. Other registered accounts allow the taxes to be deferred on the income earned within the investment portfolio. The TFSA is unique because the income earned is tax-free, i.e. it is never subject to tax.
TFSAs have been available since January 2009. Any individual who is 18 or older and who has a valid social insurance number can hold a TFSA.
The maximum contribution for a TFSA is $5,000. For years after 2009, the maximum annual contribution is increased in line with inflation. The indexed amount is rounded to the nearest $500. This means that from year-to-year, if the indexation is small, the maximum contribution amount may remain unchanged because it would be rounded down.
If you are not able to contribute the maximum amount in a given year, this creates unused contribution room, which may be carried forward indefinitely. There is no lifetime contribution limit and any money withdrawn can be replaced although not immediately.
The primary benefit is tax-free growth of income earned in the plan. You do not get a tax deduction when you put money into a TFSA but any investment income earned in the account grows tax-free whether it is interest, dividends or capital gains. If you invest for growth and end up with capital losses rather than gains, you won’t be able to claim any portion as a taxable capital loss.
Income earned in a TSFA or withdrawals will not affect eligibility for Old Age Security, the Guaranteed Income Supplement, the Canada Child Tax Benefit, the GST/HST Credit, or Age Credit. This makes the plans especially attractive for individuals whose taxable investment income would reduce benefits from these programs.
TFSA assets can be transferred to a spouse or common-law partner on death. You may withdraw money (contributions plus income) from a TFSA at any time. The amount withdrawn may be re-contributed but you would need to wait until January 1 of the following year to do so.
Mary who is in her late 50s recently lost her job and is about to start a part-time job with a major retailer who pays the minimum wage. While she can make an RRSP contribution this year based on her previous year’s earnings, and she has the savings available, she anticipates paying little if any tax this year.
She is likely better off contributing the money to a TFSA because a tax deduction from an RRSP contribution will have little if any benefit. Moreover if her circumstances change or her income increases, she can always withdraw funds from the TFSA to make an RRSP contribution up to her unused RRSP contribution room.
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