6 Things to know about your TFSA

Are you puzzled by your Tax-Free Savings Account? If so, you're not alone. A recent report commissioned by the Canada Revenue Agency says that Canadians are still confused about the rules for the popular tax shelter launched in 2009. Follow these six TFSA tips to avoid penalties, save more tax-free money, and clear up some common misunderstandings.

1. Investments grow tax-free.
A TFSA is a registered account that allows Canadian residents to earn investment income tax-free. Your TFSA contributions are not tax-deductible (like an RRSP), but you do not pay tax on any investment income earned inside your TFSA.

2. Don't over-contribute.
More than 70,000 Canadians over-contributed to their TFSA in 2010 and were hit with unexpected tax penalties due to a misunderstanding of the TFSA contribution rules. The biggest mistakes were made by people withdrawing and re-contributing funds. Here are the rules:
-Withdrawals: Withdrawing cash from your TFSA increases your available contribution room, but only in the next calendar year. So if you made a maximum contribution of $5,000 in January 2011 and then withdrew $3,500 in February (a month later), the earliest you could replace that cash would be January 2012. Otherwise, you would pay a 1% per month penalty on the $3,500 over contribution.
-Transfers: It's also against the rules to take money out of a TFSA and transfer it to a plan at another financial institution in the same calendar year -- you'll get hit with an over-contribution penalty.

3. Your income does not determine eligibility.
You don't need to earn an income to open and contribute to a Tax-Free Savings Account. To open a TFSA you must be a Canadian resident, have a Social Insurance Number (SIN), and be at least 18 years old.

4. Carry forward your unused contribution room.
Unused contribution room from previous years can be carried forward to the current year, making the maximum limit $15,000 per person in 2011.

5. Know your total contribution room.
Your TFSA contribution room each year is determined by these three amounts:
Amount One: The TFSA dollar limit for the year -- $5,000 for 2009, 2010, and 2011. TFSA contribution limits are indexed to inflation and rounded to the nearest $500, increasing the limit to $5,500 for 2012.
Amount Two: All TFSA withdrawals made in the previous calendar year.
Amount Three: All unused contribution room from the previous year.
Here's an example:
2009: Kate made the maximum $5,000 contribution in 2009. She has no unused contribution room to carry forward.
2010: Kate managed to contribute $3,000 to her TFSA in 2010, leaving $2,000 to carry forward to 2011.
2011: In 2011 Kate can now contribute up to $7,000 -- that's $2,000 carried forward from 2010, plus her $5,000 dollar limit for 2011. Kate needs the cash this year, so she withdraws $1,000 from her TFSA and does not contribute a dime in this calendar year.
2012: Kate's contribution room is $13,500 in 2012. Adding up her 2012 dollar limit ($5,500), plus her 2011 unused contribution room ($7,000), plus the amount withdrawn in 2011 ($1,000) leaves her with some sizable space to make a large TFSA contribution in 2012.

6. You can hold more than one TFSA.
You are allowed to open more than one TFSA as long as your total contributions across all TFSAs do not exceed your available TFSA contribution room.

Editor's Note: from http://blog.yourmoney.ca/

byKerry K. Taylor