This new savings vehicle was just introduced in Canada in January and most financial institutions already offer it. While the best way to choose the right product for you is to speak with your advisor, it is a good idea to have an understanding of how it works and what your options are.

First, the name “Tax Free Savings Account” is rather confusing. Most of us understand a savings account to be a type of investment which provides a low but guaranteed return and is easily accessible at any time. One may assume that TFSA is simply a savings account with extra features. But the term TFSA defines a tax status of an investment, rather than its type. Almost any investment can be classified as a TFSA, including cash equivalents, stocks, bonds, mutual funds, etc. The difference is that there is no tax on the investment income, whether it is interest, dividends or capital gain.

The effect of tax sheltering may seem small. How much can you save by eliminating tax on a $5,000 investment? Perhaps $100 a year. But due to the compounding effect you can increase your investment by over $50,000 in 20 years if you put it in a TFSA, as compared to a traditional non-registered investment earning an exactly the same rate of return.

Every adult can invest up to $5,000 (indexed) per year, regardless of income. Penalty on over contribution is 1% per month. Unused contribution room can be carried forward indefinitely. Withdrawals can be made at any time and are also tax free. Each withdrawal increases your contribution room and deposits can be made any time.

Unlike with RRSP, contributions are not tax deductible. But withdrawals which can be made at any time are tax free, while RRSP withdrawals are fully taxable. This makes it very difficult to compare TFSA and RRSP for retirement purposes on a net basis. Your tax situation today and at retirement, as well as your other circumstances and plans have to be considered to determine which option will work best for you. But if you are saving for something other than retirement, TFSA is the way to go.

Nikolay Sisan is a Certified Financial Planner and freelance writer in Vancouver.