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The TFSA was launched in January, 2009 and can be defined by what it is not.
Unlike a Registered Retirement Savings Plan (RRSP) the contributions are not tax-deductible. So you deposit after-tax cash into it, but you can withdraw it tax free. Putting money in RRSP savings accounts gives a tax deduction when you deposit it, but you later pay tax on what you take out. So a tax free savings account as the name suggests, a tax free savings haven rather than a tax-deferred shelter like an RRSP.
1. Forever tax free
You never pay tax on the money inside your tax free savings account, so you can invest in interest bearing options like bond funds and GICs, or aim for growth in the form of investments like common stocks. You can’t deduct the interest if you borrow money to invest in your tax free savings account, but the other benefits are attractive. When you take it out, it’s still tax free and it won’t affect your eligibility for income support programs based on earning levels.
2. Beware of over contributing
You are allowed to contribute $5,000 a year and carry forward the unused portion to the next year. But be careful. Many Canadians have been confused by the rules and face penalties as a result. They withdrew money from their tax free savings account in say January and then put the amount back in June. They were shocked to discover that the redeposit was considered a double payment and subject to a hefty tax penalty.
3. Save and save some more
If you need spending money, go ahead and dip in. The chunk you take out gives you equal contribution room the next year. So if you remove $3,000 for a vacation, you can contribute that same amount (in addition to $5,000 maximum) the following year for tax free savings. Just be careful not to reinvest during the same calendar year. See above.
4. Contributions carried forward
You can take advantage of your unused portions of the $5,000 annual limit at any time in your life. You may be one of those people who starts saving early (you have to be over 18 years old), even when you don’t have an income that allows you to save the maximum annual amount.
5. Compounding power
Investment advisors love the charts that show you how by putting away a few dollars a month for a lifetime, so starting early with tax free savings and being disciplined has its advantages.