In 2009, the federal government introduced the tax-free savings account, which allows Canadians 18 years of age and older to save and grow their money tax-free. Each year, you can contribute $5,000. This amount will be indexed with inflation.
Though your contributions aren’t eligible for a tax deduction, your earnings within the plan aren’t taxed. So, basically your money grows tax-free, even when it is withdrawn. With a Registered Retirement Savings Plan (RRSP), however, you’re fully taxed at your marginal tax rate when funds are withdrawn.
Similar to an RRSP, Registered Pension Plan (RPP), or other non-registered plans, you can put a variety of investments within the TFSA, from GICs to stocks to mutual funds, etc. Your contribution room is also carried forward indefinitely, so if you can’t contribute one year, you can make up for it the next year.
When you withdraw the funds, which you can do without penalty at any time, you don’t pay tax on capital gains, dividends, trust distributions, or interest earned. On the flip side of this, capital losses within the plan are not tax deductible and dividends aren’t eligible for the dividend tax credit. If you withdraw money, you can re-contribute your funds to the TFSA, one year after withdrawal. This means you, in essence, get your contribution room back.
Unlike the RRSP and RPP, the TFSA can be used for either short- or long-term saving, so a TFSA can be a great way to save for down payments, vacations, or weddings. If you invest for the long term, you’ll reap the benefits of long-term growth and additional compounded interest and reinvested returns.
Whatever your goals, the best way to use a TFSA is to maximize the allowable yearly contribution. This allows you to grow your money through compounded interest and reinvested returns.