Canadians need to save for many different purposes over their lifetimes. Reducing taxes on savings can help.
That is why the Government introduced the Tax-Free Savings Account (TFSA). It is the single most important personal savings vehicle since the introduction of the Registered Retirement Savings Plan (RRSP).
The TFSA allows Canadians to set money aside in eligible investment vehicles and watch those savings grow tax-free throughout their lifetimes. TFSA savings can be used for any purpose, such as to purchase a new car, renovate a house, start a small business or take a family vacation.
Canadians from all income levels and all walks of life can benefit.
Both an RRSP and TFSA offer tax advantages by allowing you to accumulate investment income tax-free within the plan or the account, but they have key differences.
Robert withdraws $10,000 tax-free from his TFSA to renovate his home. Robert will be able to re-contribute the $10,000 to his TFSA in future years without affecting his other available contribution room. Had he used his RRSP savings, he would have needed to withdraw up to $18,000 to pay taxes and cover the cost of the renovation, and this contribution room would have been lost.
Because capital gains and other investment income earned in a TFSA are not taxed – even when withdrawn (either as they accrue or when they are withdrawn), a person contributing $200 a month to a TFSA for 20 years will enjoy additional savings of $11,045 compared to saving in an unregistered account.
Not everyone is able to save each and every year.
Those who cannot use their entire TFSA contribution room in a given year are able to carry forward their unused contribution room to future years.
In addition, Canadians may want to use their savings—to buy a new car or a cottage, make home improvements, or start a small business—and the full amount of withdrawals can be put back into the TFSA in future years. Re-contributing the withdrawn amount in the same year may result in an over-contribution amount, which would generally be subject to a tax of 1% per month.
Couples often save and plan together, so individuals can provide funds to their spouse or common-law partner to invest in their TFSA, up to the spouse’s or common-law partner’s available room.
Gillian saves $3,000 a year for 10 years in a TFSA. She decides to start a small business and withdraws $40,000 of her TFSA savings, tax-free. A number of years later, Gillian decides to re-contribute the $40,000 to her TFSA. She may do so without reducing her other available contribution room.
Canadians will also benefit by using the TFSA to start saving early for future needs and goals.
Annette and Roger, a single-earner couple, have been saving in their TFSAs for seven years. Together, they have saved $59,000. To pay for extensive repairs to the foundation of their house, they withdraw $40,000 tax-free. They will be able to re-contribute this amount in future years.
The TFSA also provides seniors with a tax-free savings vehicle to meet ongoing savings needs, even after they reach age 71 and are required to convert their registered retirement savings into a retirement income vehicle.
François and Evelyn are retired seniors and living comfortably on François’ pension. Evelyn also receives a small pension based on her years of work after raising their children. The couple would like to save Evelyn’s pension each month and use it to spend the winter in Florida. The TFSA will provide them with an effective means to save for their trip south each year.
Neither income earned in a TFSA nor withdrawals from a TFSA will affect your eligibility for federal income-tested benefits and credits, such as the Guaranteed Income Supplement and the Canada Child Tax Benefit. This will improve incentives for people with low and modest incomes to save.
Alexandre and Patricia, a modest-income couple, expect to receive the Guaranteed Income Supplement (GIS) in addition to Old Age Security and Canada Pension Plan benefits when they retire. They have saved for a number of years in their TFSAs and now earn $2,000 a year in interest income from their TFSA savings. Neither this income, nor any TFSA withdrawals, will affect the GIS benefits (or any other federal income-tested benefits and credits) they expect to receive. If this $2,000 were earned on an unregistered basis, it would reduce their GIS benefits by $1,000.
Information is available on the Canada Revenue Agency website.
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The rate of return on investments cited in this document is hypothetical and used only for the purposes of example. This document should not be construed as a guarantee of any specific rate of interest, either expressed or implied, nor should it be considered an endorsement of individual products or organizations offering Tax-Free Savings Accounts.