TFSA (Tax Free Savings Account) Basics

by Pam on September 12, 2009

consider a tax free savings account (TFSA)At the beginning of this year, the Canadian government introduced the Tax Free Savings Account (TFSA).  While it definitely has its perks, there are some disadvantages to the TFSA as well.

Here are the basics about TFSAs:

*Canadians 18 years of age and older can invest up to $5000.00 every year in a TFSA

*The money can be withdrawn at any time.

*You can contribute to your spouse’s TFSA

*There is not a lifetime contribution limit

*Assets from a spouse’s TFSA will transfer upon death to the other spouse without tax implications

*Any funds withdrawn can be put back into the account at a later time without reducing your contribution room

*You don’t have to pay taxes on the investment gains regardless of whether they are capital gains, dividends, or interest income.

*Money contributed to the TFSA are not tax deductible

*If you don’t invest the full $5000.00 for any one year, it can be carried forward to a future year

The Good, the Bad, and the Ugly

TFSAs are generally a great concept because they encourage people to save.  The fact that you’re not being taxed on the earnings is also very appealing.  However, there are some other aspects to TFSAs that you need to consider.  You don’t want to be paying hefty fees for your TFSA, so you need to be mindful of what your financial institution charges.  Feel free to shop around before opening your TFSA.

Another thing to consider is that if your investment in a TFSA experiences a capital loss, there is no tax cushion to buffer the loss.

Lastly, when you contribute to a TFSA you are likely to be at a fairly high tax bracket and most people want to decrease their tax bracket by contributing to something such as an RRSP.  Unfortunately, TFSAs don’t give you that benefit.  In essence, you will be paying more tax if you contribute to a TFSA as opposed to an RRSP.

Each investment option has its pros and cons.  TFSAs can be a great method of investing, but like any other option, it’s not perfect.   Check out your local financial institution’s website to see what they have to offer and start saving for your current and future goals.

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