The Tax‐Free Savings Account (TFSA) is an account that allows individuals to earn tax‐free investment income. Canadian residents aged 18 years or older can open and contribute to a TFSA Account.
TFSA contributions are not tax deductible; however, any investment income within the account will not be taxed, even when withdrawn. This investment income has also no effect on your Old Age Security (OAS), Guranteed Income Suppliment (GIS) or Canada Child Tax Benefit. As contributions are not tax deductible, receipts are not issued or even necessary for filling an income tax return. However, there is a limit of contribution to TFSA account in a year which can be accessed through “My Account” on the CRA website.
Tax‐Free Savings Account (TFSA) Vs RRSP: Which One is better?
TFSA and RRSP are both popular investment vehicles in Canada. Both have some merits and demerits.
RRSP contributions are tax deductible, and any withdrawals will be taxed when funds are withdrawn. On the other hand, TFSA contributions are not tax deductible; however, any investment income within the account will not be taxed, even when withdrawn.
The decision to contribute to a TFSA, an RRSP or both will depend upon your income level, savings and investment objectives, as well as your current and expected future financial situation.
The net after‐tax rates of return on a TFSA and an RRSP are equivalent when effective tax rates are the same at the time of contribution and withdrawal. The value of the tax deduction available for RRSP contributions is equivalent to the value of withdrawing funds from a TFSA on a tax‐free basis.
However, when an individual’s income and tax bracket are expected to increase over time, a higher after‐tax rate of return would be earned by contributing to a TFSA during the lower income years and making withdrawals during the higher income years.
The opposite is true with an RRSP. When an individual’s income and tax bracket are expected to decrease in retirement, a higher after‐tax rate of return would be earned by contributing to an RRSP during the higher income years and making withdrawals during the lower income years.
The after‐tax rate of return from investing in either a TFSA or an RRSP is greater than that of a non‐registered investment account.