What is a TFSA and How Does it Work?

Many Canadians are confused as to what a Tax Free Savings Account (TFSA) is, and how it works exactly.

Here, I'll give you the basic points to help clear the air:

1. Why: The main purpose of a TFSA allows you to save money and not have to claim any interest earned as income. 

For example: If you earn $200 on a normal investment, you would normally have to claim that $200 as income earned on your taxes. Therefore, after you file your taxes, you would be left with far less than $200. However, if your investment is under the TFSA umbrella, you do not have to claim any of your interest earned as income. Therefore, you keep the whole $200. 

This doesn't sound like a big difference, but if you make greater returns using the stock market for example, then it becomes a big deal. Moreover, if you're in a high income tax bracket, you can lose close to half of your interest earned if your investment wasn't in a TFSA.

2. Type: A TFSA can be applied to almost any personal investment. Whether it's a normal savings account, GIC, or invested in the stock market, you can shelter the investment in a TFSA. Just make sure you don't go over your limit between your different TFSAs. Keep in mind a TFSA can't be joint with anyone else. It is a registered product with the Government.

3. Limits: As of 2013, the maximum you can contribute to your TFSA is $25,500. The government will announce how much will be added next year to the total, however it generally increases by about $5000.

4. Contributing: Be sure to understand how contributions work. If you over contribute, you may receive a penalty from the Government. If you open a TFSA this year and have never contributed before, you can contribute the full $25,500 if you have it. You are then allowed to withdrawal some of the funds if you need to during that year, however you can't re-deposit funds until the following year. 

For example: At the end of 2012, you have $20,000 + interest in your TFSA. You then contribute $5,500 to your TFSA in 2013 to top up to the limit of $25,500. Then you withdrawal $8000 due to a family emergency.  You are not allowed to re-deposit that $8000 in 2013. You have to wait until 2014 to re-deposit the $8000. Additionally, you are also allowed to contribute whatever amount the Government raises the limit to.

5. Demographics: You may not be entitled to the same limit as the majority of others depending on your age, and how long you have been a Canadian citizen. As of 2013, if you have been a Canadian citizen for less than 5 years, or are under the age of 23, please check here to view what your contribution limit would be: http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/tfsa-celi/cntrbtn-eng.html

If you have any other questions that I didn't answer here, just leave a comment or go to the Official Government TFSA Page. Hope that helps!

I want to start investing some money...where do I start?

So you've just graduated, and you're going to start rolling in the dough. Or you've simply decided it's time to start saving and investing your money better for the long term. Well here are the basics:

Disclaimer: I'm not going to go into the specifics of each investment option here; these are just going to be general rules to get you going and to get you into the right mindset. In the future, I'll get into what each type of account means and how they work. Also, if you don't know what RRSPs, TFSAs and GICs are...don't worry, I'll get into that stuff later. 

Here are some basics to get your saving started properly:

1. Save 10% of your paycheque and put it in RRSPs. This option is especially great if your employer will match up to a certain percentage of your contributions (usually 3 - 6%). Keep in mind, you can always withdrawal money from your RRSPs to buy your first home. I know you're still young to put away money for retirement, but trust me, the younger you save, the more your money will exponentially grow. Plus, if you don't end up needing to go into your RRSPs for your first house purchase, you've gotten a huge head start towards retiring early.

2. Put any additional savings into a Tax Free Savings Account (TFSA). Banks generally offer higher interest rates on TFSA accounts rather than normal savings accounts. Plus, you can have access to typical TFSA savings accounts at any time as long as you don't lock the funds in. As of 2013, you can deposit up to $25,500 into your TFSA, assuming you have been a Canadian citizen for the past five years.

3. If there is any chance you may want to buy a house in the next 5 years, Do not lock in your money! I can't stress this enough. In this day and age, banks don't offer GICs that offer significantly higher interest rates than typical savings accounts (especially if it's a TFSA). I've seen it time and time again where young people lock in some of the savings they have, and then have to withdrawal it with a penalty because they decided the wanted to purchase a house. Unless you are an incredibly conservative investor and have no desire to purchase a home within 5 years, stay away from GICs, they aren't worth it.

4. Finally,  stick with your plan! You may not be able to get the faster car or the nicer rental apartment, but you'll be happy you stuck with it in the end. A penny saved is truly a penny earned.