Understanding the benefits of a Tax-Free Savings Account

Understanding how a Tax-Free Savings Account (TFSA) works can give you financial flexibility and another investment option at tax time. So what does this mean for you?

The biggest benefit of a Tax-Free Savings Account is that the money invested in them can grow tax-free for life.

• You can withdraw funds at any time without paying a penalty or tax, should you have a major expense you need to take care of.

Essentially, any Canadian older than 18 years can start a Tax-Free Savings Account, and contribute up to a certain amount per year.

• You can contribute as little as you wish, up to the limit, but you cannot contribute over the yearly limit without a penalty.

Although the contributions are not deductible at tax time, the money you earn (i.e., which is accrued) remains tax-free.

One interesting advantage of a TFSA is that it can include more than cash contributions.

• A Tax-Free Savings Account can also include investment income, such as dividends or capital gains, and these also remain tax-free even when withdrawn.

That means that your TFSA can contain mutual funds or a GIC, which gives you greater financial flexibility in how you plan your portfolio.

While the yearly maximum is fixed (based upon the Consumer Price Index), a great advantage of having a Tax-Free Savings Account is the carry-over flexibility it offers.

For instance, if you do not contribute the maximum this year, whatever difference remains can be carried over to subsequent years, increasing that year's maximum without any upper limit. The advantage?

• This mechanism allows Canadians a greater range in their contributions year-over-year, which can be reassuring in uncertain financial times.

And as before, whatever money is in the TFSA can be withdrawn at any time without impacting your taxes or incurring a penalty.

Basically, the best-laid financial plans tend to be more diverse as they maximize profit and minimize risk. For that reason, a Tax-Free Savings Account is an ideal option for Canadians who want to build a tax-free nest egg year after year without incurring penalties should circumstances arise that require them to withdraw funds for travel, renovation or other unexpected expenses.

Everyone wants to keep as much of their hard-earned income as tax-free as they possibly can. While RRSPs are a popular choice come tax time, a Tax-Free Savings Account can allow both a tax-free shelter and financial flexibility should a major expense arise.