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Tax-Free Savings Account
Plainly, the Tax-Free Savings Account (TFSA) is a savings account that offers taxbased incentives for saving purposes in Canada. A more technical characterization
of TFSA involves referencing the general purpose savings option as a flexible
means of allowing Canadians to register for and earn a tax-free investment
income that better suits respective lifetime savings objectives. This extends itself
to dividends, capital gains, interest and other investments, where capital and
income can be withdrawn tax-free. This, however, depends on the type(s) of
investments held in a TFSA. Despite the name, TFSAs are not mandated to be cash
savings accounts. A TFSA is permitted to hold investments that are similar in
nature to that held by a Registered Retirement Savings Plan (RRSP). These include
mutual funds, Guaranteed Investments Certificates (GICs), publicly traded
securities, cash, Exchange-Traded Funds (ETFs) and bonds. Installment Receipts,
royalty units, and depository receipts, along with a myriad of other investment
instruments are eligible.
Mostly, TFSA was established to complement and plug any holes that existed in
the existing RRSP in a bid to provide a more thorough network of tax-free savings
options for Canadians.
The inner workings of the TFSA have changed slightly since the passing of the
decree granting its enactment in January 2009. The idea of a Tax-Free Savings
Account was introduced by then Canadian Minister of Finance, Jim Flaherty. Since
that time, the maximum annual contribution (its limit) has inched up from $5000
at the passing of the legislature to $5500 in 2013 and ultimately to $10000
starting 2015. Also important to note is starting in 2009, TFSA contribution room
accumulates each year. In which, the contributor is 18 years of age or older,
possesses a Canadian social insurance number and is a legal resident of a
Canadian province. Any unused contribution room can be brought forward
without any upward restrictions. Similarly, any withdrawals from a TFSA in a year
will be added to the contribution room the following year. In the event that the
maximum allowable TFSA contribution has been reached, and funds are then
withdrawn, such an individual must wait until the next year before any further
contributions can be made. Otherwise, tax penalty charges will be incurred, in
accordance to those laid out by the Canada Revenue Agency.
Example: In July 2016, Dustin, a Canadian, opened his first TFSA and then
contributed the maximum amount of $41,000. The following month, he withdrew
$10,000. The earliest point that Dustin can re-contribute to his TFSA without
incurring any penalties is January 1, 2017.
In the same vein, in the event that the allowable TFSA contribution is exceeded,
the tax authority - The Canada Revenue Agency (CRA) will allow an imposable tax
rate of one percent (1%) per month. This will last for each month or a part thereof
for as long as the excess contribution continues to remain in the TFSA account.
This 1% tax will continue to apply until either the excess portion is withdrawn or
when the addition of the unused contribution room for the subsequent year for
TFSA is absorbed by the excess amount. The latter, however, only applies to
Whilst a Tax-Free Savings Account provides a great savings alternative for
Canadians, generally, the savings option is best suited for individuals who have
fully capitalized on their Registered Retirement Savings Plan (RRSP) contributions
and who are now desirous of further tax-free saving opportunities. The TFSA may
also prove to be particularly beneficial to elderly residents who are apprehensive
about their respective earnings from investments affecting Canadian benefits.
Based on income (these may include Old Age Security benefits, as well as other
federal programs such as the Guaranteed Income Supplement). Withdrawals from
a Tax-Free Savings Account, therefore, have no impact on one's eligibility for
TFSA: Working For You
The Tax-Free Savings Account offers up a multiplicity of benefits to savers,
regardless of the objectives or reasons for saving. As a result of the account's
flexibility, it can be used by an array of savers, ranging from college/university
students to newlyweds or the young professional. This makes the TSFA an ideal
alternative for both short and long-term investment goals and funds can be
withdrawn without fear of taxation.
RRSP vs. TFSA:
The RRSP or (Registered Retirement Savings Plan) is a tax-deferred savings
account that came into being primarily for retirement purposes and it still
considered to be most effective in that regard. It is also the predecessor of the
Tax-Free Savings Plan and now complements the TFSA. Many similarities and
differences abound between the two (2) savings options, all of which prove to be
advantageous to respective subsets of savers, depending on uses, reasons for
saving, investment options and desired outcomes. In fact, both the RRSP and the
TFSA can be used together.
Some such differences are as followed:
With a Tax-Free Savings Account, individuals are required to have an income in
order to amass Contribution room. On the other hand, a Registered Retirement
Savings Plan mandates that individuals have a source of income for the purposes
of accumulating contribution room.
Tax-Free Savings Account-based withdrawals are tax-free. With the exception of
qualifying transfers, funds withdrawn are added to the contribution room for the
following rear. As a result, it is possible to re-contribute the funds previously
withdrawn. With regards to the RRSP, withdrawals are taxed in the year that the
funds are withdrawn (with a few exceptions – LLP (Lifelong Learning Plan) and
HBP (Home Buyer's Plan)). Therefore, funds withdrawn are not added to the
contribution room for the following year.
For RRSP, contributions are tax deductible on income tax returns purposes. The
opposite is also true for TFSA.
Using the Registered Retirement Savings Plan, funds much be withdrawn fully or
be transferred to an annuity or the Retirement Income Fund (RIF) by yearend of
an individual's 71st birth year. This is not the case with a Tax-Free Savings Account,
as there are no stipulations for conversion of the TFSA to any income payment
options at 71 or any age, for that matter.
In the event of bankruptcy and financial demise resulting from legal proceedings,
assets held within an account holder's TFSA are not given protection from the
individual's creditors. Those held within an RRSP account are protected, however.
With regards to cross-border regulations, the United States' Internal Revenue
Service (IRS) does not recognize a Tax-Free Savings Account as a pension plan; the
Registered Retirement Savings Plan is however. As a result, tax agreements and
settlements negotiated between the United States and Canada are not applicable
to TFSA and may result in Canadians being slapped with up to 15% US tax
withheld being paid on dividends on shares in US-based corporations.
Registered Retirement Savings Plan (RRSP) accounts are primarily geared towards
retirement while Tax-Free Savings Accounts can be used for just about anything.
These include saving to buy a car, to go on vacation or to purchase a house; TFSA
is a general-purpose savings account.
Under the Tax-Free Savings Account, unused room contributions are carried
forward indefinitely, while unused contributions under the Registered Retirement
Savings Plan are only eligible for carry-forward until the age of 71.
There is no maximum age for contributions to the TFSA, but the RRSP has an age
cap of 71 years.
There are no lifetime contribution limits with the TFSA, as is the opposite case
with an RRSP account.
Similarities also exist between an RRSP and a TFSA. These similarities are not to be
viewed as overlapping frameworks and policies, but rather as a means of
providing the benefits of one savings account to the other savings account, which
further fortifies whichever choice an individual makes.
These similarities are outlined below:
Generally, a TFSA is permitted to hold investments that are similar in nature to
that normally held by a Registered Retirement Savings Plan (RRSP). These take
into account Guaranteed Investment Certificates (GICs), mutual funds, as well as
cash and certain stocks bonds.
Neither RRSP nor TFSA joint registered accounts are permitted.
New contribution room is created for each year under both the RRSP and the
Over-contribution penalties exist for both the TFSA and the RRSP, though through
different mechanisms – for both, an imposable tax rate of one percent (1%) per