What is the Tax-Free Savings Account (TFSA)?
The Tax-Free Savings Account came into effect in January 2009. Since 2009, for each year, you get a contribution room of $5000. The contribution room was raised to $5500 since 2013. Every 5 years, the contribution room will be increased by $500.
At any time, you can withdraw funds from the Tax-Free savings account tax-free. If you withdraw funds from it, those funds can be put back into the TFSA next year. In addition, if you have some contribution room unused from earlier years, that contribution room is brought over to subsequent years.
If you have multiple Tax-Free Savings Accounts, the combination of those contributions cannot exceed your total contribution room. For example, you might have one for a high-interest savings account, and another for GICs.
Who is Eligible for the Tax-Free Savings Account?
The Tax-Free Savings account is available to Canadian residents 18 years and older who have a Social Insurance Number.
What are the Benefits of Using the Tax-Free Savings Account?
Essentially, all growth happening in the TFSA is earned tax-free, even at the time of withdrawal.
You can build an emergency fund in the Tax-Free Savings Account because you can withdraw from it anytime.
You can use it as a savings vehicle, such as for saving up for a vacation, a future purchase, or even for retirement. Make sure to be disciplined and stick to your original intent of using the money saved in the TFSA.
Examples of how TFSA Contributions (and Withdrawals) work
~ Scenario 1: Never contributed before ~
If you were at least 18 years old on January 1, 2009, your Tax-Free Savings Account contribution room up until 2013 is $25,500.
$5000 * 4 = $20,000
$5500 * 1 = $5,500
~ Scenario 2: Contribution Room Left from Previous Years ~
Up till the end of 2013, you have a contribution room of $18,500.
~ Scenario 3: Contributed Some and Withdrew Some ~
To keep the scenario simple, some assumptions had to be made:
- you deposited funds into your TFSA on January 1st of each year, and buy a stock immediately after, so that you’re reaping the dividends for the full year (and thus earning the dividend yield for the year)
- the dividend yield is 3% for all the stocks we purchased from the amount in the Contributed column
- you’re withdrawing all dividends to treat yourself to your favorite coffee or drink and that we never touch the principal
- the yield stays static for the 4 years, (which we don’t want to happen as investors! We want the dividends to grow.)
|2010||$5000 + $150||$3000||$240|
|2011||$5000 + $2000 + $390||$4000||$360|
|2012||$5000 + $3000 + $750||$2000||$420|
|2013||$5500 + $6000 + $1170||$3000||$510|
|2014||$5500 + $8500 + $1680|
By the end of 2013, excluding any possible capital gains (which would be earned tax-free), you would have earned a total of $1680 from dividends. In 2014, you would have a contribution room of $15680.
~ Calculating the 2014 Contribution Room ~
2014 Contribution Room = contribution room for current year + room left from previous years + any amount you withdrew from previous years (and haven’t deposited back in) = $5500 + $8500 + $1680
In my next article on the Tax-Free Savings Account, I talk about which investments you should consider. And most importantly, avoid experimenting in the TFSA, because losses cannot be written off. See Investing in the Tax-Free Savings Account.
Learn how the Tax-Free Savings Account works from the Government of Canada.
Disclaimer: I am not a certified financial advisor. This article is for educational purposes, so consult a financial advisor and or tax professional if necessary before making any investment decisions.
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