Refreshing the basics of a Tax Free Savings Account
I recently met with a client who had many questions about a Tax-Free Savings Account (TFSA) and how it works. Later, I met with a young man to set up his first TFSA. Then I returned to the office and on my desk was an article regarding TFSAs vs traditional non registered accounts. It surprises me that so many people still donèt really know what a TFSA is and can do. Here is a quick refresher on what a TFSA is and how it works.
What is a tax-free savings account?
A Tax-Free Savings Account is an account that a Canadian can set up to tax shelter their savings. From 2009 to 2012 a Canadian 18 years or older could put in $5000 per year into a TFSA. Since 2013 to present the same Canadian can put in $5500 for 2013, 2014 and 2015. The interest/income/gain earned is tax free when withdrawn which makes the Tax Free Savings Account one of the most tax-efficient vehicles out there.
Related article: Different accounts for saving money
How does the Tax-Free Savings Account work?
For example, in 2009 a Canadian could put $5000 into a TFSA. In 2010, that same Canadian could put another $5000 into a TFSA. At any point, the owner of the TFSA can withdraw any amount. In the following calendar year, that investors can put that withdrawal amount back into the TFSA. This is one of the more interesting features of a TFSA.
Also, unlike an RRSP that has to be converted to an RRIF at age 71, Tax-Free Savings Accounts have no end date. Contributions can go in every year until the owner of the TFSA passes away.
Related article: Contribution and withdrawal rules of the TFSA
What can a TFSA invest in?
What can be held within a TFSA? Pretty much anything. You can hold GIC’s, stocks and mutual funds. Depending on your risk tolerance and time frame you can use a TFSA for short term savings or you can use it to complement your retirement portfolio.
Related article: Investing your TFSA
What happens at the death of the owner of a TFSA?
When the owner of a tax-free savings account passes away the Designated Beneficiary receives the proceeds of the TFSA tax-free at the time of death. Any interest earned in the TFSA after the date of death will be attributed to the beneficiary. An example is Joan has $15,000 in her TFSA with her daughter Mary as the beneficiary. Joan passes away. Mary is the beneficiary of the $15,000. However, from the date of Joan’s death to the time the claim was processed Joan’s TFSA earned another $300 dollars. That $300 dollars will be taxable to Mary. If the beneficiary is a spouse or common-law partner they can contribute the amount received as a death benefit to their own TFSA without affecting their own TFSA room. If the beneficiary is not a spouse or common-law partner, they can contribute the proceeds as long as they have an unused room.
Related article: Understanding different beneficiary designations
A Successor Holder can be appointed (spouse or common-law partner at the time of death) who will acquire all the rights of the original holder. Basically that means taking over the TFSA.
Tax-Free Savings Accounts are probably one of the best ideas that the Government has come up with since RRSPs.
Related article: TFSA vs RRSP
It is a brilliant tool that can help Canadians save in the most tax-efficient manner and for whatever savings goal they wish, short or long term.