Business Basics: TFSAs

A stress-free way to minimize your taxes

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Supplied by Pexel

Don’t let the acronym’s lack of sexiness deter you from a savings plan your future self will thank you for.

If there’s one thing everyone hates, it’s taxes. They’re ubiquitous, constantly eating away at your hard-earned income and involve a lot of headache-inducing paperwork. But there’s ways to pay your dues while investing your income, namely a Tax-Free Savings Accounts (TFSA).

A TFSA is a registered savings program created by the Canadian government that offers critical tax advantages. TFSA’s allow individuals aged 18 or older and who possess a social insurance number (SIN) to contribute money which grows tax-free each year.

Any income generated from the TFSA, such as investment income and capital gains, are tax-free. Unlike retirement plans such as an RRSP, account holders may freely withdraw and deposit money from their TFSA at any time and suffer no taxation or penalty.

A key restriction of TFSA’s is that there is an annual contribution limit. Contributions over the annual limit incur tax penalties.

So how do I open a TFSA?

TFSA’s are offered by financial institutions (banks), credit unions, or insurance companies. The simplest way to open a TFSA is to make an appointment at your local bank and fill out an application with a financial advisor. Bring your SIN and a piece of government-issued photo ID.

Investing with Your TFSA

Commerce kids, listen up. TFSA funds don’t have to sit stagnant in a savings account, but can be used to purchase eligible investment instruments. These include mutual funds, stock exchange-listed securities, guaranteed investment certificates (GICs), bonds and certain small business corporation shares.

Neither capital losses nor gains alter your contribution room. If you originally purchased stocks for $5,500 and they depreciated to $4,000, this doesn’t mean that you are eligible to contribute a further $1,500 to your TFSA. Likewise, if you originally invested $4,500 and your investments appreciated to $5,500, you are still eligible to contribute a further $1,000.

The Mechanics Behind Your Contribution Room

Your contribution room is defined as the amount of money you are still eligible to contribute to your TFSA without exceeding the limit. Contributions to your TFSA reduce your contribution room accordingly. Simple stuff, I promise. 

Tax penalties defeat the purpose of a TFSA, so it’s important to understand exactly how contributions work. The actual penalty is a 1 per cent tax on the highest excess amount in the month, for each month that the excess amount remains in the account.

The annual contribution limit has varied year by year. The 2016 contribution limit is $5,500, which was reduced from $10,000 in 2015.

If you’re over 18 and still haven’t opened a TFSA, don’t worry. Your contribution room rolls over annually, even while you don’t have a TFSA. A 20-year old who just opened a TFSA would be immediately eligible to contribute the sum of the past three annual contribution limits.

Be careful when making withdrawals from your TFSA. When you withdraw, your contribution room does not go up by the same amount until the beginning of the next year. For example, if you maxed out your TFSA in 2016 by contributing $5,500 and then withdrew $500, your contribution limit remains $0 (not $500) and you cannot re-contribute that $500 until 2017.

In Summary

TFSA’s are one of the most powerful tools at your disposal for saving money tax-free. They pose an especially excellent opportunity for students to be mindful of personal finance.

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