TAX FREE SAVINGS ACCOUNT (TFSA)
Tax Free Savings Account or TFSA is an account that provides tax benefits for saving. Contributions to a TFSA account are not deductible for income tax purposes but investment income, including capital gains, dividends and interest earned in a TFSA are not to be taxed while invested nor is there any tax implication upon withdrawal
TFSA is an investment option for individuals wanting to save for the future. The flexible structure in TFSA allows the holder to be able to withdraw money from the account any time free of taxes. The allocations into the account are non-deductible; however this represents a lucrative opportunity for individuals with left-over income to invest in a saving vehicle, without the pressure of time constraints. TFSA account also alleviates the burden of the capital-gain tax, which means the interest-income will be able to compound tax-free. In essence, the account holder can withdraw any amount out of the account, free from capital gains and/or withdrawal taxes.
One mechanism in the design of the TFSA is the carry-over aspect. Any unused space under the $5,000 cap can be carried forward to subsequent years, without any upward limit. The TFSA also allows income splitting to an extent, because a higher earning spouse can contribute to the TFSA of a lower-earning spouse.
The tax treatment of a TFSA is the opposite of a Registered Retirement Savings Plan (RRSP). There is a tax deduction for contributions to an RRSP, and withdrawals of contributions and investment income are all taxable. In comparison, there will not be any tax deduction for contributing in a TFSA, in addition there is no tax on withdrawals of investment income or contributions from the account.
Up to $5,000 per year can be placed into a TFSA. This money can then be withdrawn at any time without incurring a penalty. Unlike an RRSP, which must be withdrawn after the holder turn 71, the TFSA does not have an expiry date. The contribution room for funds withdrawn from a TFSA is then reallocated in the tax year after the withdrawal, unlike an RRSP, where contribution room is permanently reduced once a contribution is made.
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