Money & Career

What is a tax-free savings account?

Author: Canadian Living

Money & Career

What is a tax-free savings account?

This story was originally titled "Save It For Yourself" in the February 2011 issue. Subscribe to Canadian Living today and never miss and issue!

Saving for a family vacation? Looking to supplement your child's education fund or your own retirement savings?

A tax-free savings account (TFSA) may provide the flexibility you need to put money away for the future – without taking a stinging bite out of your savings today.

Canadians have been able to contribute to TFSAs since January 2009 and, according to the Canada Revenue Agency (CRA), more than 4.8 million Canadians have opened one. In the first year alone, they deposited more than $18 billion. Here's how TFSAs work.

What is a TFSA?
Tax-free savings accounts are available to anyone over the age of 18.

You're allowed $5,000 in contribution room per year, and that carries over from one year to the next.

So, if you only put in $2,000 in 2010, you can deposit up to $8,000 in 2011. And if you haven't opened an account yet, you'll actually start with $15,000 in contribution room ($5,000 each for 2009, 2010 and 2011).

Seniors and lower-income earners may find they can really benefit from this account. The money you deposit and the interest you earn is not considered income, and therefore any federal benefits (such as Old Age Security or the Canada Child Tax Benefit) you receive are not affected, says Cleo Hamel, a senior tax analyst with H&R Block in Calgary.

Page 1 of 2 – Learn why TFSAs are unique on page 2
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Buyer beware
Despite its name, it is possible to be taxed on this account.

If you deposit more than your allotted amount for the year, you'll be taxed one per cent of the over-contribution amount each month until more contribution room opens up.

You can withdraw money anytime, but keep tabs if you deposit as well. It's not the balance of the account that matters; it's how much has been put in.

Some people diversify their portfolio and open TFSAs at multiple financial institutions, says Hamel. "But you can’t open two accounts and have $5,000 in each. It has to be $5,000 total." Your Notice of Assessment will indicate how much room you have.

You can also check your status on the CRA’s website; visit cra.gc.ca and click on "My Account."

TFSA versus RRSP
Both TFSAs and RRSPs have the same investment options, such as GICs or bonds, says Judith Cane, a financial adviser in Orleans, Ont.

One big difference, though, is that when you withdraw money from your RRSP, you have to pay a withholding tax (usually between 10 and 30 per cent), says Hamel.

And you have to close your RRSP and convert it to a registered retirement income fund when you turn 71; with the TFSA, you can contribute for as long as you like, says Cane.

Can my spouse and I have a joint account?
TFSAs are individual accounts, and money cannot be transferred from one person’s account to another's.

However, in the event of a death, the account can be transferred to the surviving spouse.

And unlike with an RRSP, the surviving spouse won’t have to settle any outstanding taxes.

Page 2 of 2 – Read the basics on TFSAs on page 1
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