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There is a lot of confusion about Tax Free Savings Account or TFSA. The situation is borne out by the wrong notion of people about the “saving account.” While it is true that you can maintain a savings account with the TFSA, you can also utilize the TFSA to purchase stocks, bonds, mutual funds and GICs. The TFSA is basically a shell that is similar to RRSP, as both instruments present opportunities for investment growth tax free.

Here are the essential features of TFSA:

1. Any Canadian citizen, 18 years of age or older, is qualified to make an investment up to a maximum of $5,000 annually.

2. No taxes will be levied on any gains and this will include capital gains.

3. There are no withdrawal limitation for the money deposited in TFSA

4. Any amount of money that is withdrawn from the TFSA can be re-deposited after a certain period of time and will not have any effect on the contribution room.

5. Any used portion of the contribution room for a particular year can be forwarded and credited to the succeeding year.

6. TFSA has no lifetime contribution cap

7. Assets from the TFSA account of a deceased spouse can be transferred to the surviving spouse tax free.

Financial experts are seeing the upsides of TFSA. This plan comes as a welcome breather for Canadians amid the declining and low interest rates. Its attractive tax exemption feature is considered as the clincher for this plan. However, there are certain concerns that you must be aware of when considering TFSAs. The contribution cap of $5,000 and the fees that will be charged are the two major concerns by most financial managers and investors.

That being said, there are basic differences between TSFA and RRSP. The main difference is on the time you can infuse funds and the time you can take them out. Under the general guidelines of RRSP, you are entitled to a tax refund once you infuse funds in the plan while withdrawal at retirement will be levied with the appropriate tax. On the other hand, you are not entitled to any refund when you infuse funds on TFSA, but you will also don’t have to pay any tax upon withdrawal. In addition to this, your withdrawal will not have any effect on your contribution room and you can make another deposit in the following year.

During its first year, you may opt for a high yielding savings account in your TFSA which can serve as your emergency fund. But you have to remember that this is not the best option if you are looking at TFSA as a viable tax strategy. It would be better for you to opt for high earning investment instruments in your TFSA since you will not have to pay taxes. Using the same decision parameter, it is better for you to place low earning investment instruments such as GICs and bonds into RRSPs. You will end up getting the same amount of refund for the funds that you infuse. And when you finally withdraw your money upon retirement, the amount of tax that you have to pay will not be as much as that with REITs or stocks.

Another great thing about TFSA is that you can use this as your income tax shelter. If you are going to purchase income trusts such as REITs in your TFSAs, you can withdraw the returns as a tax-free continual income. If you are planning to push your limit then it is wise for you to incorporate stocks since these investment instruments are considered tax efficient and are your best pick outside of TFSAs and RRSPs.

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Tax Free Savings Account FAQ:

Question: When you pay back your HBP are you not effectively paying tax on the portion that was “sheltered” interest?
If you use your RRSP savings to put a down payment on a home, when you pay it back (with taxed income), are you not effectively paying tax on what was initially sheltered interest? Why would you use your RRSP to buy a home if this is the case? Wouldn’t you be better off using a TFSA?

Answer: I think you are misunderstanding something here. When you made the initial contributions to your RRSP, you received a tax deduction, thus the contributions were made with before-tax dollars. When you took out the money under the HBP, you did not pay any tax on the withdrawal.

When you repay the HBP, you are using after tax dollars, but you never paid tax on the initial contributions or withdrawals. Thus your conclusion that you are paying tax on the sheltered portion is fallacious.

Using a TFSA is an option to save up for a down payment but the difference is that you don’t get a tax deduction up front for contributions to the TFSA. Therefore, the RRSP/HBP is advantageous, especially for higher income earners.

Question: Should I put money into my car loan or rrsp loan?
I will be getting back about $2000 back from tax refund this year and am wondering what the smart thing to do with it is. I have a car loan that I owe about $15000 on, and an rrsp loan that I owe $4000. The car loan has a higher interest rate then the rrsp loan. I am not having trouble paying either of them off. I am thinking about buying a house and think it might help if I don’t owe a bunch of money to the bank. Another option is to put it all into a tfsa.

Answer: Normally you pay down the loan with the highest interest rate which is most likely the car loan. If you are seeking a mortgage, wait before paying either loan and see a mortgage specialist. They will work with you for free and determine the best thing to do with the excess cash (down pmt vs debt payment).

Question: Canada’s Tax Free Saving Account?
Are we allowed to open TFSA in two different banks? And what about RRSP’s?

Answer: Yes you can open as many TFSA or RRSP accounts as you wish but your restricted to the same contribution limit total for all accounts.

Question: In Canada – Should you Max out your RRSPs? Use a TFSA? Stick with Non-Registered Funds?

Answer: All 3 are completely different products for different purposes. This shouldn’t be an either or question.

Personally, I think the TFSA is being marketed for the completely wrong reasons by the banks and such. This account should be used for long term investing, not saving for a holiday or something. The amount of taxes on savings in one year is minimal, so why waste your TFSA space to save $6 in interest?

RRSP’s are a good start for retirement savings, but you should also have non-registered investments as well, to avoid the big tax bill when you cash them in and so you have something accessible in case of an emergency.

It all boils down to what people can afford and what assets they have available to them and what their goals are.

Question: Credit card debt or TFSA?
The government and banks are pushing the new Tax Free Savings accounts. Should you start to put money in one if you’re still carrying a balance on your credit card?

Answer: I think both. TFSA is saving for your future, which I think is a very good idea for individuals. But at the same time you can pay your credit card debt at least minimum payment. You have to balance savings and paying debt.

Question: Mutual Funds from banks or private brokers?
I am wondering whether I should invest in mutual funds from the banks (i.e. BMO or RBC) or from the private online brokers such as etrade. Good things about banks’ is that I can easily put the funds in my TFSA, and I don’t necessarily have to pay the commission fee separately. But is there any great advantage from online brokers’ mutual funds?

Answer: If you intend to stay in mutual funds, it may be more convenient to invest through a bank. However, if you wish to purchase individual stocks or ETFs one day, you will have to go to a brokerage. Remember, all major Canadian banks have their own on-line brokerages too. My preference would be to go to TD Waterhouse or BMO Investorline. I have a TD Waterhouse account and have a TFSA with them.

If you do wish to stay in mutual funds only, you may want to look at some very low fee index funds offered by BMO Investorline. Keep in mind that most mutual funds under-perform the index they are using as a benchmark. Even if you find a “star” manager, he/she may move to another company. Therefore, you might as well stay with index funds or ETFs.

Question: Are Tax Free Savings accounts insured?
Are the new Canadian TFSA’s insured like RRSP’s?

Answer: Yes and No. It depends on what type of investment you hold under the TFSA. Essentially, the TFSA is a non registered investment so it would not be insured. However, if you were to hold a segregated mutual fund under the TFSA you would receive creditor protection because it is an insurance based product. Some segregated funds offer 100% protection of the face value, while others only offer 75% protection. Just make sure you choose the right one for you.

Question: Are there any capital gains tax for Canadians on u.s. investment?
I’ve just opened a tax free savings account (tfsa) and was wondering if I’m subjected to any capital gains tax on u.s. stock investment or will this tax free savings account only applies to Canadian investment? Also if we are taxed on our gain, what are the rates? Is there going to be a long term and short term rate just like in the u.s.? Or will we just be charged a flat rate of 50%, or so I’ve heard.

Answer: US Stocks held in an account in Canada by a Canadian resident are absolutely not subject to US capital gains tax, unless you are a US Citizen too (in which case the TFSA is pointless). US Stocks held in a Canadian account are deemed to be Canadian property and are taxed accordingly. Also, the capital gain tax rate is 50% of the regular tax rate, not a 50% tax.

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