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Are There Any Tax-Free Savings Accounts in the USA?

Written by Banks Editorial Team

Updated December 21, 2021​

4 min. read​

tax-free savings accounts

A tax-free savings accounts USA (TFSAs) is the best way for individuals to save towards their financial goals. The capital gains and investment income earned from TFSAs are usually free from tax. As a result, it gets easier to save money for short-term and long-term goals. In addition, these accounts complement other saving plans such as Registered Education Saving Plans (RESPs) and Registered Retirement Savings Plans (RRSPs). TFSAs are similar to PRSPs since the account holders have the opportunity to invest in one or more products including Guaranteed Investment Certificates (GICs), government bonds and mutual funds.

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Different Types of Tax-Free Savings Accounts

Tax-free savings accounts exist to enable individuals to save for short and long-term financial goals such as education, a down payment for a mortgage, or a vacation. All the income earned from these accounts is usually tax-free, and unlike an RRSP, one does not receive a tax refund for any contributions made. With a tax-free savings account, you can easily grow your savings much faster as a result of the compounding process. TFSA are federally insured, which means up to $250,000 of the money in your account would be covered if the bank failed.

The different tax-free savings accounts can be issued by banks, credit unions, insurance companies, or trust companies. There are two types of tax-free savings accounts: a regular TFSA account (a deposit account, annuity contract, and an arrangement in trust) and a self-directed TFSA account:

  • A regular account is opened with a financial institution, and the investment options are restricted by the proprietary options of that financial institution.
  • Self-directed TFSAs offer investment opportunities which are not accessible to regular accounts. The accounts enable individuals to invest in all qualified investment options including mutual funds, publicly traded shares, small business corporation shares, bonds, royalty units, debt obligations, and mortgages.

How to Choose One

When opening a tax-free savings account USA one should select a bank that has account insurance. This type of account lets you grow tax-free investment income (i.e., interest, dividends, and capital gains) earned on the contributions made using already taxed income. The target group for TFSAs includes individuals from all income levels, i.e. young adults saving for a special project; individuals having reached RRSP contribution limits who are seeking an alternative tax-sheltered savings vehicle; and retirees who don’t need all of the retirement income.

As of 2020, the Tax-Free Savings Account (TFSA) contribution limit is $6,000. If you have never contributed to a TFSA and have been eligible since its introduction in 2009, your cumulative contribution room will be $69,500 in 2020. This limit is indexed annually and rounded off to the nearest $500). It would be wise to opt for a TFSA rather than a traditional non-registered savings plan since the returns are tax-free and available when you need them.

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Benefits of a Tax-Free Savings Account in the USA

A tax-free savings account has several benefits:

  • Growth of the investments is tax-free: You will not pay taxes on the interest, dividends or capital gains earned.
  • Tax savings allow the TFSA to grow faster than a taxable investment account.
  • Flexibility to withdraw your savings at any time and for any purpose you choose.
  • A wide range of investment options including mutual funds, guaranteed investment certificates (GICs), stocks, bonds, and cash.

Any withdrawals made in a calendar year will create additional contribution room the following year. For example, an individual contributing $200 a month to a TFSA for 20 years (assuming an average annual return of 5.5 percent) will accumulate about $11,045 more in savings than if the investment had been made in a non-registered account.

How to Open One

To open a TFSA account, you are expected to contact your financial institution, insurance company, or credit union then provide the issuer with details (date of birth and social insurance number) for registering you for a TFSA. There are several benefits of TFSA. First, any amount withdrawn from the tax-free savings accounts can be re-contributed in future years without reducing contribution room. Another is that spouses (and common-law partners) can give each other money to contribute to their own TFSA as long as it is within the maximum allowed. TFSA assets can also be transferred to a spouse, tax-free, upon death.

The Challenges of a Tax-Free Savings Account

While you can hold a Tax-Free Savings Account, U.S.-company dividends received in your TFSA are subject to a 15% withholding tax. While this may be a deterrent for you, Canadian retirement accounts have more generous contribution limits and fewer distribution restrictions than their American counterparts (traditional IRA’s and Roth IRA’s).

Canada’s RRSP vs. America’s Traditional IRA

Canada’s Registered Retirement Savings Plans (RRSPs) allow investors to receive a tax deduction on their annual contributions. Money invested in the plan grows tax-deferred, which advances the benefits of compounded returns. Contributions can be made until the age of 71, and the government sets maximum limits on the amount you can contribute into the RRSP account (18% of a worker’s pay, up to $27,230 for 2020). Investors can contribute more, but additional excesses over $2,000 will be hit with tax penalties.

There are no restrictions on withdrawals from RRSPs, but withdrawals are classified as taxable income and subject to withholding taxes. In the year in which the taxpayer turns 71, the RRSP must be either cashed out or rolled over into an annuity or Registered Retirement Income Fund (RRIF).

For American taxpayers, a traditional IRA is structured to provide the same sorts of benefits as an RRSP, whereby contributions are tax-deductible and capital gains are tax-deferred until distributions out of the account are realized.

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Canada’s TFSA vs. America’s Roth IRA

Canada’s Tax-Free Savings Account (TFSA) is fairly similar to the United States’ Roth IRAs. Both of these retirement-focused vehicles are funded with after-tax money (there’s no deduction for the contribution), but they do grow tax-free, and withdrawals are not taxed. One advantage to a TFSA is that savings for retirement are able to carry over their contributions to future years (this option is not available with America’s Roth IRAs). For example, if a taxpayer is 35 years old and unable to contribute $6,000 into their account one year, then in the following year, the total allowable amount accumulates to $12,000.
Now that you know how tax-free savings accounts work, it’s time to comparison shop and see if this option is right for you!

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