First, what is a tax free savings account? According to the Canada Revenue Agency TFSA website:
Since January 1, 2009, Canadian residents who are 18 years of age or older with a valid Social insurance number (SIN) are eligible to contribute up to $5,000 annually to a TFSA.
The initial amount contributed as well as the income earned in the account (for example, investment income and capital gains) is tax-free, even when it is withdrawn.
In simple terms, a Tax Free Savings Account allows you to save money tax free; you don’t get a tax deduction when you make a contribution (like you do with an RRSP), but all income earned in the TFSA accumulates tax free, so you pay no taxes when you take money out.
For example, if you contribute $5,000 per year, after 5 years you would have saved $25,000. If you earned interest or dividends or capital gains on this investment, you might have $30,000 in your TFSA. You could withdraw the entire $30,000 and not pay any tax. If you earned $5,000 outside of your TFSA you would have been taxed on it.
So, today’s tip: if you have savings outside of your RRSP and you want to invest them and pay no tax, a TFSA may be a good option for you. But, there are tricks to watch for, so tomorrow we will discuss those tricks.