How does a TFSA work?
A tax-free savings account is a registered savings vehicle, where contributions are made with after-tax dollars and withdrawals are tax free. This means that money can be earned in the account and withdrawn at any time without being taxed.
TFSA versus a non-registered account
Capital gains and other investment income earned in a TFSA are not taxed.
So, if you contributed $5,000 a year for 20 years to a TFSA, you would enjoy a total tax savings of $51,865 over a non-registered account.
Assumes a $5,000 annual contribution for 20 years, a 6% rate of return and an average tax rate of 45%.
The table shown here is used only to illustrate the effects of the compound growth rate and is not intended to reflect future values of invested contributions. The rate of return is for illustrative purposes only.
As of 2009, any Canadian resident over the age of 18 can save up to $5,000 every year in a TFSA. The $5,000 annual contribution limit will be indexed to the Consumer Price Index and rounded to the nearest $500. There is a 2% rate of inflation, the first increase was in 2012 and is now $5,500.
TFSA vs Taxable Investment
Use this calculator to compare the growth of a TFSA to a taxable investment.
To see an example of how to calculate TFSA contribution room click here.
Source: CI Investments Inc.
Tax-free savings accounts can be valuable tools in financial planning. They can be used in many ways – for an emergency fund, for short or medium-term savings for a specific purpose, to generate supplemental income, or for long-term investments.
