A Tax Free Savings Account (TFSA) is a registered savings account that allows people age 18 and over to earn investment income tax-free.
You are not alone if the words “investment income tax-free” already have you sweating bullets down your forehead. It’s okay to have a fear of investing, a fear of financial terms, and a fear of learning something now without having an authoritative figure beside you to guide you along.
However, it is not okay to plead ignorance and never venture into investing because it’s something you didn’t study in school. A TFSA is a very… I repeat, VERY, simple concept to grasp and financial instrument to use because you don’t really have to do anything at all apart from watching your money grow.
Contributing into a Tax Free Savings Account
When you contribute to your Tax Free Savings Account, as in depositing money into this savings account, there is a contribution limit you must look out for. As of 2017, the annual contribution limit for a TFSA is $5,500.
What does this mean? It means you can only invest $5,500 for the year of 2017 if you have already maxed out your TFSA from year’s prior. Luckily for you, you are opening your first TFSA this year and are able to invest up to $52,000 this year. Why? Well, because your contribution room carries forward indefinitely.
TFSAs originated in 2009 and an individual’s contribution room has increased every year because, as I mentioned, it carries forward.
Here is a chart that explains further, whereby Contribution Limits represents how much everybody’s contribution room increased that year and Total Allowance represents the total everybody could have invested into their TFSA by that given year. Please note: Total Allowance values are valid only if the client was at least 18 years old in 2009.
As you can see, if you already had $46,500 by the end of 2016 in your TFSA, you would only be able to add $5,500 into it for all of 2017. Since your contribution room carried forward year by year and this is the first TFSA you’ve ever opened, you can deposit up to $52,000 into it right away.
Withdrawing from a Tax Free Savings Account
One of the main benefits of a Tax Free Savings Account is how easily you can redeem your money when you like. Unlike a Registered Retirement Savings Plan (RRSP), you do not have to worry about being taxed on what you withdraw. This is because you already paid taxes on that money before you deposited it into the TFSA. For example, the income you receive from work gets taxed instantaneously, as seen on your paycheck. Therefore, removing those dollars from your TFSA will not have you taxed again.
A TFSA withdrawal is not taxable, can be made at any time whatsoever, and has no required minimum or maximum withdrawal amount. However, the one primary rule you must remember when making a withdrawal from a TFSA is this:
The net amount withdrawn from a TFSA adds back to your available contribution room in the year following the withdrawal.
This means if you currently have $52,000 sitting in your TFSA and it’s the year 2017, what you withdraw cannot be contributed back into the TFSA until the year 2018. For example, if you redeem $4,000, your available contribution room will still remain at $0.00. When 2018 rolls around, the CRA will then record you as having only contributed $48,000 at this point, meaning you can now put your money back in.
Investing with a Tax Free Savings Account
You might be thinking this is just a bunch of information about how a Tax Free Savings Account works with nothing explaining why you shouldn’t just keep your money in your chequing account.
Generally, a TFSA is right for those people saving for short-term goals because withdrawing is simple and tax-free. Also, those people in a lower tax bracket benefit from TFSAs more than they would in RRSPs because they pay a smaller percentage of tax on their income and don’t require high-end tax-sheltered savings plans.
A TFSA grants you a seamless entry into investing with mutual funds, stocks, and other financial derivatives.
Long story short, investing with a TFSA effortlessly grows your money and you’re straight-up nuts if you don’t want free money.
Personally, I took the simplest route there is when I first opened a TFSA. I went to my closest TD Bank branch, sat down with an available financial advisor, and answered a short “Investor Questionnaire” that determined how risk-averse I was. We decided upon a mutual fund I’d invest in, I gave them a lump sum of my money, and that was it! It took ten minutes.
Since then, my money has grown and grown. Yes, of course you can lose money if the mutual fund or stock performs negatively but in the long-term investments, especially mutual funds, tend to grow and perform positively. As the name of TFSAs advertise, the gains you receive on your investments are tax-free as well.
What I can say for sure is I’d rather have the extra money that my investment grew to than having just the original amount sitting in my chequing account, doing nothing.
“A wealthy person is simply someone who has learned how to make money while they’re not working.”
– Robert Kiyosaki
Lessor known facts about a Tax Free Savings Account
- Be careful when contributing to your Tax Free Savings Account whilst you’re near the Total Allowance limit. The CRA charges a tax of 1% per month on the excess amount remaining in your TFSA.
- This tax remains until you withdraw the entire excess amount.
- Age requirements:
- You cannot open or contribute to a TFSA until you turn 18.
- On the year you turn 18, you can contribute up to the full TFSA dollar limit for that year.
- You do not accumulate contribution room prior to age 18.
- A TFSA is only available in Canada.
- If you reside in the United States, a Roth Individual Retirement Arrangement is comparable to a TFSA.
- Those living in the UK can open an Individual Savings Account that has similar tax advantages to a TFSA.
- Mutual funds:
- TFSAs use these financial instruments most commonly when helping to grow your money.
- You have the choice to invest in risky, conservative, or balanced mutual funds. Your choice will determine how greatly your money fluctuates, positively and negatively.
- For more on the world of investing, be sure to check out Benjamin Graham’s “The Intelligent Investor: The Definitive Book on Value Investing”. As seen on the book’s cover below, even Warren Buffet himself calls it “By far the best book on investing ever written”!
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