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Tax Free Savings Accounts

Let’s talk about Tax Free Savings Accounts (TFSA). The government does not give you many chances to save on taxes, this is definitely one you should be taking advantage of. You have been allowed to contribute to a tax free savings account since 2009, with varying maximum annual contribution limits.

You do not have to contribute annually, or even the maximum annually, and all limits can be carried forward to future years indefinitely. TFSA contributions can be made all year, not to be confused with RRSP contributions which have to be made by the 60th day of the year to qualify for the current income tax filing deadline. If you were able to maximize your contributions, you have been allowed to contribute a total of $46,500.

Banks may lead you to believe that the TFSA is a bank account, earning a low account interest, but the fact is that the TFSA investments can be made in GICs, individual stocks, ETFs, bonds or mutual funds.

Typically, some mutual funds and stocks that pay dividends will earn more than a GIC at current interest rates. Even though dividends and capital gains are taxed more favorably than GIC interest, it may be more beneficial to hold investments with these types of earnings in your TFSA.

So, which is better for your situation – a RRSP (registered retirement savings plan) or a TFSA? A general rule is if your tax rate will be the same or higher in retirement than currently, using an RRSP isn’t as attractive an option for you, but it really does depend on your specifics: current income & tax bracket, income expected in retirement & tax bracket.

In some cases it might even make sense to pull money out of a RRSP and invest it in a TFSA. If you have a lower income for a year or two, aren’t drawing CPP or OAS yet and haven’t converted your RRSP to a RRIF, it is a viable strategy.

Some people use their TFSA as a savings vehicle for an upcoming holiday or a large purchase, or an emergency fund. Do not use the account as a savings account with multiple withdrawals a year – it becomes difficult to monitor, and, although the government will allow you to re-contribute the withdrawal amounts there are restrictions.

The funds cannot be replaced until the following year or quite substantial penalties of 1% per month for the over contributed amount is applicable.

If you have a choice, timing withdrawals towards the end of the year are best since you can replace the funds as early as January 2 the following year.

Please contact me if you have any questions or with a topic you would like addressed in a future article.

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