What Is A Tax-Free Savings Account (TFSA)? – Importance, Benefits, And More

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What is a TFSA account? – This is a Canadian savings account that allows you to grow your contributions, interests, capital gains, and dividends, free from taxes. Once you withdraw money from that account, that withdrawal is also tax-free. This is because the money that you deposit in the TFSA is after-tax money. That is, you already paid for the income taxes before contributing to those accounts.

In this article, you will learn some of the most essential details about what a tax-free savings account or TFSA is. Apart from that, you will also learn about how a TFSA works and what are its major features. Furthermore, we will share with you details about how a TFSA account works. Finally, you will also learn how a TFSA account allows you to invest. Hence, to learn more about TFSA accounts, read on through to the end of the article.

Contents

What Is a TFSA (Tax Free Savings Account)?

According to Investopedia,

A tax-free savings account (TFSA) is a Canadian savings account in which contributions, interest earned, dividends, and capital gains grow tax-free. Money withdrawn from it is also tax-free. The money deposited in TFSAs is an after-tax contribution, meaning it’s made with money that’s already been taxed. Therefore, it doesn’t reduce taxable income.

Although TFSA is primarily a savings account, it can still hold investments, including securities, bonds, mutual funds, as well as cash. If your age is 18 or more, and you are a Canadian, you can use the account for many different purposes. It is basically an all-in-one account, which is a quite simple option for banking.

Basically, the TFSA account can provide a tax shelter for your investments and all the interest that you have earned inside the same account. As of 2023, you contribute up to $6,500 to your TFSA account.

The Canadian Federal Government introduced the TFSA in 2009. After its introduction, the TFSA quickly became popular with investors in the country. This is because this account acted as a vehicle for savings that allowed investors and general people to keep their money within a tax shelter. More than half of the population of Canada keeps their money in a TFSA.

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How Does A TFSA (Tax Free Savings Account) Work?

How Does A TFSA (Tax Free Savings Account) Work

Basically, the TFSA offers you a lot of benefits if you live in Canada and you want to contribute to the account. Some of them are given below:

Tax Benefits

Unlike a regular savings bank account, a TFSA will offer you tax-free interest gains, as well as gains on your investments. This is one of the huge benefits that you will get with a TFSA.

Limits To Contribution

There are annual contribution limits to TFSA accounts. However, this is not applicable to regular savings accounts. Furthermore, there are unique advantages to TFSA accounts as compared to regular savings accounts. These accounts are equipped for the need of investments.

Interest Rates

The interest rates that you earn with TFSA accounts are subject to change, just like normal savings bank accounts. The average rate of interest on TFSA accounts is 2.60%, while in some accounts, the percentage of interest on TFSA is 4.10%. However, the latter is often offered by digital banks or credit unions.

How To Use A TFSA (Tax Free Savings Account)?

You can use a TFSA if you have a valid SIN (Social Insurance Number) in Canada. The account basically allows you to save a certain amount of money every year without having to pay taxes on your earnings. On average, a TFSA account holds $34,917, as per a 2022 study by BMO Savings.

According to Nerdwallet,

A TFSA is similar to other registered plans, such as a Registered Retirement Savings Plan, or RRSP. The main difference with a TFSA is that although you don’t get a tax break when you contribute, you would not pay any capital gains tax to the Canada Revenue Agency (CRA) when money is withdrawn.

As the name suggests, basically, a tax-free savings account does a lot more than what a savings account does. Apart from making the money in the accounts tax-free, these accounts also hold a variety of investments like GICs, bonds, securities, and mutual funds. All these investments and securities are tax-free once they get inside the TFSA.

What Does The TFSA Allow You To Invest In?

According to the Government of Canada’s website,

You do not need to have earned income to contribute to a TFSA. The maximum amount that you can contribute to your TFSA is limited by your TFSA contribution room. All TFSA contributions made during the year, including the replacement or re-contribution of withdrawals made from a TFSA, will count against your contribution room.”

How you want to invest in TFSA and how you can use it depends on your financial and future goals. Some people use the TFSA for short-term savings, while some people use the TFSA for long-term savings like retirement or stock market investments. If you want to contribute to your TFSA account, you will need to have a savings goal in mind.

For the year 2023, the contribution limit to TFSA is $6,500 annually. If you were eligible to contribute in previous years but did not have cash, you cannot the unused amount gets added to the next year. Thus, your contribution room increases every year. However, there is a limit to the total contribution, too. As of 2023, the total contribution limit is $88,000.

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Bottom Line

Hope we have been able to explain to you what is tax free savings account (TFSA) in a simple manner. These accounts are tax-advantaged accounts that are available to adults residing in Canada. The best thing about TFSA is that it allows you to save money on taxes since your investments are not taxed, and your withdrawals are also not liable for taxes.

However, there is a contribution limit to TFSA (contribution room). However, if your contributions are less than the annual limit, you can take the carryover amount to the allowed contribution next year. What do you think of TFSA? Share your opinions with us in the comments section below.

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