5 Reasons To Love Your Tax Free Savings Account (TFSA)

I always get a little giddy in January. Ok, I’m giddy most days, but January is especially spine-tingling because the New Year marks another opportunity to save money in my Tax Free Savings Account (TFSA). The TFSA is a brilliant vehicle for Canadians looking to stash some extra cash for a rainy day or to save for a new home, car, or even for retirement without paying ANY tax on the income earned. Yay!

If you’re 18 or older, you can open a TFSA at your financial institution of choice and save up to $5,000 in cash, stocks, or bonds every year tax-free. Are you getting giddy with me yet? Here are 5 reasons to love your Tax Free Savings Account:

tax free savings account tfsa

1. Earn tax-free income in your TFSA: Contributing up to $5,000 a year to your TFSA saves you from paying taxes on income earned in the account. For example, investing $5,000 at 3.5% gives you $175 tax free in one year.

2. Your TFSA savings add up: Over time the savings in your TFSA can really add up. For example, let’s assume you have $25,000 invested in a standard high interest savings account at 3%. After one year you’ll earn $760.40 compounded monthly. Depending on your marginal tax rate, the CRA takes around $225. With a TFSA, you get to keep everything. These savings will continue to add up too, especially if you continue to contribute annually.

Want to see the money add up? Check out this Savings Calculator to see when you’ll be a millionaire!

3. Your TFSA is flexible: Your TFSA is also far more flexible than a Registered Retirement Savings Account (RRSP) since you can withdraw your cash and the contribution room is carried forward to the next calendar year. So if you need a new roof or have a car repair then you can use your TFSA — just be sure to replace the money in the next calendar year to avoid penalties.

4. You can carry forward: If you can’t find the cash to save in a TFSA this year then don’t worry — you can carry forward your unused contribution room to future years.

5. Your TFSA won’t impact other income-tested programs: If you’re receiving Employment Insurance (EI), the Guaranteed Income Supplement (GIS), the Canada Child Tax Benefit, or any other income-tested benefit from the government then there’s no worries of a claw back if you withdraw from your TFSA. Neither your income earned in a TFSA nor withdrawals affect your eligibility for benefits or credits.

Watch out for over-contribution penalties!
Here are two common mistakes Canadians made when withdrawing funds from their TFSA in 2010:

  • Yes, withdrawing cash from your TFSA increases your available contribution room, but only in the next calendar year. So if you made a maximum contribution of $5,000 in January 2011 and then withdrew $1,350 in February 2011 (one month later), the earliest you could replace the money would be January 2012. Recontribute sooner and you’ll pay a 1% per month penalty on that $1,350 over-contribution.
  • Moving your TFSA money around to various institutions could trigger a tax penalty since it’s also against the rules to take money out of a TFSA and transfer it to a plan at another financial institution in the same calendar year — you’ll get hit with an over-contribution penalty.

Your Two Cents: Do you contribute to a TFSA?

Your two cents:

  1. W.Peter Sears March 31st, 2010

    Lets get realistic where do you get 3% in a high interest savings account? The maximum you will get is .75%. On $ 5000 thats $37.50,and then the bank could charge you up to $100 management fee.Someone has not done their homework.

  2. Kerry March 31st, 2010

    @W.Peter Sears There’s hope! Interest rates are low these days, but the Manitoba credit unions (at the time of this comment) are offering a 5-year GIC at 3.85%, with no account fees. See Achieva Financial for their rate charts. You don’t need to hail from this province to invest either.

  3. W.Peter Sears March 31st, 2010

    Unfortunately,In your initial blurb, you did not mention the 5 year GIC hold.Most or all investors want to know what they can get per year. Spell it out correctly.Regards W.Peter

  4. Kerry March 31st, 2010

    @W.Peter Sears Hi again. The numbers I give in this post are clearly stated as examples, showing readers the power of investing in an a TFSA. My purpose is not to give updated GIC or savings rates at financial institutions across Canada. The Globe and Mail has a website widget that solves that dilemma. Although, I am happy to point anyone in the direction of a better TFSA deal when they ask. 🙂

  5. Koolsaver February 18th, 2011

    Fox,

    I have a TFSA with PC Financial and I am curious as to how you are able to invest in Stocks within your TFSA? Would I have to set up TFSA account with company that I do my trading with (Scotia Itrade)?

    Thanks,

    Koolsaver

  6. stu lach February 20th, 2011

    TFSA’s are great in retirement. You can fill them with dividend stocks,withdraw the dividends for taxfree income monthly and recontribute the total years withdrawal amount in the next year along with another $5000 worth of div’ stocks. Last month we contributed a total of $11650 to our TFSA’s for 2011. Doesn’t get any better than that.You could do the same when building your retirement nest egg. I would suggest reinvesting the TFSA withdrawals in a taxable investment account throughout the year and transfering holdings from this account to your TFSA every January. Everyone’s been brainwashed about RRSP’s but I feel that if you used the above strategy in both a TFSA and an RRSP you would have about the same in each after say 25yrs. The big difference would be you owe no tax on the TFSA and tax on 100% of the RRSP. The tax already paid on the $ put in the TFSA would amount to $150,000 over the years. But the tax owing on the RRSP would be “at least” double that even “if” you happened to be in a lower tax bracket in retirement. For young couples starting out $10G’s a year might be as much as they could afford so the TFSA is better. One of the talking heads on BNN recently said if you make approx $65,000 or less TFSA’s are best and above that figure RRSP’s are better. Anyway that’s my $.02 worth. Great blog you’ve got here Fox, thanks.

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