As the name suggests, a tax-free savings account (TFSA) is designed to help you build savings by protecting your investment from taxation. That means the savings you put in a TFSA could grow far more quickly than if they were left in a different type of savings vehicle.
In addition, when you go to withdraw money from your TFSA, you won’t have to pay any taxes. And should your TFSA increase in value, you won’t have to pay taxes on the growth.
This makes the TFSA a popular savings vehicle. It can be used to set money aside for virtually any type of purchase – from post-secondary tuition to a home to a new vehicle.
Of course, there are some limitations to the TFSA. For one, you have to be at least 18 years of age to open one. You also need to be a resident of Canada and you must possess a valid social insurance number.
Perhaps the most significant limitation of the TFSA is the contribution limit, which is set every year by the Government of Canada. Currently, the annual contribution limit is $5,500. The good news is that, if you don’t reach this limit, your contribution room is carried forward at the beginning of the new year.
Comparing RRSPs and TFSAs
One major alternative to the TFSA is the registered retirement savings plan (or RRSP). Generally, you can contribute far more each year to an RRSP – in 2016, roughly $25,000 or 18% of earned income, whichever is less. And, as with the TFSA, contribution room rolls over at the beginning of a new calendar year.
Another major difference between the TFSA and the RRSP is that with an RRSP, you receive a tax deduction when you contribute; however, your withdrawals from an RRSP are subject to income tax.
What’s best for you?
Ultimately, the decision to go with a RRSP, TFSA or some other kind of savings vehicle will depend on your unique situation. If you expect to need your money sooner rather than later – say, you’ve just gotten married and you’re thinking about buying a bigger home – then the TFSA may be a better option.
Additionally, if you expect your income to increase over time, it may be wise to contribute to a TFSA now, when you’ll pay less income tax each year. Then, when you’re earning a higher income later on, contributing to an RRSP can help you receive a bigger upfront tax deduction.
Of course, in a perfect world you’d maximize your contributions to both types of accounts. If that’s not possible, it’s a good idea to speak with a financial security advisor to help you determine which type of account best suits your unique needs.
1 Keep in mind that a pension adjustment may reduce the RRSP deduction limit. Speak with your financial security advisor to learn more.
2 Your federal notice of assessment will show you the amount of your unused RRSP and TFSA contributions.
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