Q: What's a Tax-free Savings Account (TFSA)?
A: It's a government-sponsored investment account, and you should have one.
So, what is it exactly? Well, first of all it’s not a savings account. We don’t know who decided to call it that. Think of a tax-free savings account (TFSA) as a basket. You can pick what to put in that basket from a bevy of financial instruments—exchange traded funds, guaranteed investment certificates, stocks, bonds and yes, actual savings accounts. And whatever gains you make from the investments in that basket are tax-free. The Canadian government introduced TFSAs in 2009 as a way to encourage people to save money for retirement. Since you paid tax on the money you put into your TFSA, you won’t have to pay anything when you take money out.
There’s a limit to how much you can put into a TFSA, of course. If the past is any measure, those limits go up a little every year. Right now, you can contribute a maximum of $5,500 a year. You’re eligible to start as soon as you’re 18 years old.
What are the pros? The main pro is that you’re nuts if you don’t take advantage of it.
First, of course, is the benefit that’s right there in the name. When you open a TFSA you don’t have to pay tax on the money you put in. If you invest $1,000 right now and it becomes $10,000 by the time you retire, that $9,000 you’ll have earned is tax-free.
Second, unlike your Registered Retirement Savings Plan, your TFSA allows you to quickly and easily take money out any time you want. There is no penalty to withdraw money— and if you do, the amount is added to how much you can contribute the following year. For example, withdrawing $5,000 this year means that next year you’ll be eligible to contribute the normal $5,500—plus $5,000.
A bonus for retirees: The money you withdraw from a TFSA isn’t considered income, so retirees can take money out without it affecting retirement benefits like Old Age Security, which decreases with higher income.
Anything to be careful about? Because TFSAs are so popular and plentiful and you can open as many as you want, it’s easy to lose track of how much you’re contributing. If you accidentally over-contribute (i.e., put in more money in a calendar year than you’re allowed by law), you will be charged a penalty of 1% per month on the amount in your TFSA that is in excess of the limit.
Finally, remember that you can’t day-trade stocks in your TFSA, unless you’d like to experience the wrath of the Canadian government’s tax department