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:
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?