Since the government started the Tax Free Savings Account (TFSA) two years ago, it has been massively popular. However, many people still do not understand the difference between this account and a Registered Retirement Savings Plan (RRSP) or the Registered Education Savings Plans (RESP). Essentially, the TFSA is a flexible, registered general-purpose savings plan that allows Canadians to earn a tax-free investment income more easily than using the other two.
Here’s how it works: Any Canadian resident aged 18 or order can contribute up to $5,000 annually to a TFSA and the investment income earned as well as withdrawals from the account are tax-free. Unlike an RRSP, where a tax deduction is given when it is deposited, but tax is required when it is paid out, a TFSA is a tax free rather than a tax-deferred shelter. One can put money into the account tax free and take it out tax free.
The maximum allowable amount to be put into the account is $5,000 before there are penalty taxes. Unused contributions can be carried forward and accumulated for future years.
The full amount of withdrawals can be placed back into the account in the future, but contributing in the same year can be subject to the penalty tax. For example, if money is withdrawn in January and placed back in December of the same year, the total contribution would be considered $10,000 rather than $5,000 and penalties will apply. Yet if that $5,000 was re-deposited the following year, that would not incur penalty charges.
The contributions are not tax-deductible and the income earned or withdrawals will not affect eligibility for federal benefits and credits such as Old Age Security, Guaranteed Income Supplements and the Canada Child Tax Benefit. Funds can also be given to spouses or common-law partners for investing and assets can normally be transferred to the significant other upon death.
Only residents of Canada can open a TFSA account. If a Canadian resident leaves the country after opening an account, that amount can be maintained, but new funds cannot be added.
There is also wide variety of investment options such as mutual funds, GICS and bonds for the TFSA available.