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Once you identify which goals you are saving for and determine an appropriate investment plan, the next step is to figure out which investment account type is right for you. Some choices may be more obvious than others, like using an RRSP to save towards retirement, or an RESP to save for your kids' education. But what about shorter-term goals like purchasing a car or saving for a wedding?
If you're asking yourself this question, a Tax-Free Savings Account (TFSA) might be the right vehicle for you and your goals. Use these tips below to help you determine if you should open a TFSA.
What is a TFSA?
A TFSA is a registered, general-purpose account type which is available to Canadians aged 18 and older. While TFSAs are not tax-deductible like RRSPs, any investment income and capital gains earned inside the account are tax-free, even when you withdraw funds from your account.
When should I use a TFSA?
TFSAs are great for shorter and medium-term goals, since there’s no tax implication on cashing it out, and your savings grow tax-free. For this reason, a TFSA should always be your go-to account before you ever use a non-registered account, which taxes all investment distributions and capital gains made inside the account. While we always recommend investing for the long-run and only withdrawing funds for big financial goals, TFSAs give you the flexibility to grow your savings faster than if you were to park your money in a basic savings account, and use the funds on larger purchases.
While you can use your TFSA account for any goal, as a general rule, TFSAs are a good choice for any major purchases outside of retirement and education savings. RRSPs and RESPs have specific benefits for their respective goals; in a similar sense, TFSAs have specific benefits for major purchase savings. Whatever your goal, it’s important to remember that a TFSA is not a chequing account and you should only be drawing funds from it for major purchases and life goals.
When does it make sense to use a TFSA for retirement?
Typically, most Canadians will pay higher income tax when they are working than when they are retired. For that reason, it makes sense to use your RRSP to save for retirement so that taxes are deferred to retirement (when your tax rate is lower). In that case, a TFSA would only be used towards a retirement goal once you run our of RRSP contribution room. If, however, you are in the situation where you expect your income in retirement to be higher, then it would make sense to use your TFSA before your RRSP first for any retirement savings.
How much can I contribute to my TFSA?
Each year, there is a new limit on how much you can deposit into your TFSA. For example, the limit for 2017 is $5,500. However, if you're opening your first TFSA this year, you can backfill your contribution room, so your cumulative limit is up to $52,000 depending on when you became eligible for the account. When you withdraw funds from your TFSA, your contribution limit will grow by that amount the year after you make the withdrawal. You can also hold multiple TFSAs, but the contribution limit is the same across all accounts.
Overall, a TFSA is a well-rounded option for those looking to save for shorter term goals and take advantage of the tax-free benefit. If you have a goal in mind and are ready to put your TFSA account to work, click here to see an investment plan that we would recommend.