Tax-Free Savings Account

We have been asked quite a few questions about Tax-Free Savings Account (TFSA) at the office lately and I thought it would be a good topic for this month’s column.

A TFSA is a registered savings plan, which allows any Canadian resident of 18 years of age or older to earn investment income that is tax-free. The contribution limit is of $5,000 per year and you can withdraw your funds at any time. To take advantage of the flexibility of withdrawals, you should consider investing your savings in a combination of investment such as high interest savings account, GICs and mutual funds.

The contribution limit for TFSAs has been set to $5,000 per year until 2011 and may increase in 2012. The unused contribution room and withdrawals from previous years can be carried forward. For example, if you contributed $4,000 and withdrew $2,000 in 2009, you will have a total contribution room of $8,000 for 2010, that is $5,000 for 2010 and $1,000 of unused room and $2,000 from the withdrawal from 2009. The penalty for over contributions is of 1% per month.

The advantage of TFSA is that you can invest and withdraw your funds and earn interest, dividends and capital gains without having to worry about any tax implications. For example, it will not affect your eligibility for government benefits such as the Canada Child Tax Benefit and Old Age Security.

TSFAs are a great short-term savings plan that can be useful for emergency funds, a down payment on a car, vacations, tuition, home renovations, weddings, etc. They can also be used if you have “maxed-out” your RRSP contribution limit.

If you are wondering how to invest $8,000 for a period of 2 to 3 months, you may consider opening a TSFA for $5,000 and putting the balance of $3,000 in a high interest saving account. Unfortunately, the interest earned on the $3,000 will be taxable.

Please consult with a representative from your bank or credit union to find out about the different investment options that may suit your needs.