What is a TFSA?
Gail Bebee took advantage of Canada Revenue Agency's little gift this year and set up a Tax-Free Savings Account (TFSA). The 58-year-old Toronto author of No Hype — The Straight Goods on Investing Your Money invested the maximum annual amount permissible — $5,000 each. But why?
Bebee won't get a tax credit for the money she invested in her TFSA, as she would if she put funds in a Registered Retirement Savings Plan (RRSP). Nor will she get a Canadian government grant on her money, as she would if she invested in a Registered Education Savings Plan (RESP) for the kids. And yet, Bebee figures everyone who can afford it should open a TFSA, and some people would be better off rerouting cash allocated to their RRSP into a Tax-Free Savings Account instead. "It's one of the few ways you can avoid paying tax," Bebee contends.
In an attempt to explain how you can use the new TFSA to strengthen your bottom line, we've compiled a list of the some of the most common questions. Read on to achieve enlightenment — or at least to dispel some of the confusion.
At the risk of sounding like a commercial — what the heck is a TFSA anyway?
Simply put, the Tax-Free Savings Account is a new savings vehicle that allows earnings to accumulate tax-free. Canadians over age 18 can contribute to a TFSA. The beauty of the account ultimately lies in its flexibility, points out Bebee. You can withdraw as much cash as you want from a TFSA without paying tax on it. You won't even lose the contribution room — you can replace the money the following year or any time thereafter. By contrast, says Bebee, "if you take money out of an RRSP, you've lost the contribution room and you'll never get it back." (Ten ways to save for your retirement fund.)
What good will it do me?
Because of the TFSA's versatility, it can be used for any number of purposes. Among them:
- Supplementing retirement income. "If you can afford to maximize your RRSP contributions and invest in a TFSA to supplement your retirement income, that's ideal," says Bebee. Remember, earnings accumulate tax-free, and the less tax you pay, the more money your investments earn overall.
- Stashing away cash for your kid. If your teen isn't keen on higher education, but you still want to set aside some money for his future, you can invest money in an account for kids 18-plus to get them started on a house down payment, a trip abroad or a wedding fund. (Of course, they also have control over the cash, so if they have a passion for fashion, you might not choose this option.)
- Saving money to go back to school. Want to boost your earning power with an MBA? Right now, under the RRSP Lifelong Learning Plan, you can withdraw up to $20,000 from your RRSP over a 10-year period to fund higher education. The drawbacks: Firstly, you have to repay that cash, and secondly, the RRSP loses the growth potential of those funds. With a TFSA, you can contribute up to $5,000 yearly to cover educational expenses and leave your RRSP alone. Your TFSA earnings accumulate tax-free and you won't pay a tax penalty when you withdraw the funds. You have no obligation to pay those funds back within a defined time period, although you do regain the contribution room.
- Setting aside cash in case of an emergency. In today's shaky economy, an emergency fund containing three to six months' worth of expenses should top everyone's list of must-haves. A TFSA is a great place to accumulate a rainy-day stash since both earnings and payouts are tax-free. It's handy if, for instance, the car breaks down and you need cash right away to fix it.
