Saving up the money to fund your startup small business may require some patience, but it definitely offers an advantage. As opposed to getting a loan from a bank, your new business doesn’t start off in debt. Instead of getting startup financing from a venture capital firm, you don’t have to give up an interest in your future profits. Consider using a tax-free savings account to save the money to fund your startup.
A TFSA is an excellent vehicle for accumulating money to use for short-term or long-term savings goals. The money in your TFSA grows tax-free, and withdrawals are also tax-free. Neither the income earned in your TFSA nor your withdrawals affect your eligibility for for income-tested government benefits or tax credits.
As of 2016, you can contribute up to $5,500 per year to a TFSA. That is your total annual contribution room, the limit of which is indexed to inflation. However, any unused portion of your contribution room is carried forward into the next year. Also, any withdrawals you make are added to your contribution room for the following year. Therefore, if some emergency arises and you need to withdraw funds while you’re saving up to fund your business, you could withdraw some money from your TFSA tax-free, and then be allowed to make extra contributions the next year to replace that money, all without penalty.
Savings Vehicles: TFSA vs. RRSP
There are key differences between a TFSA and a registered retirement savings plan in terms of taxation and other issues. Understanding these differences can help you understand which type of account will work better for your savings needs – and why a TFSA is a better account for saving money for starting up or growing your business.
An RRSP may convey a higher annual contribution limit compared to a TFSA, depending on your income. The annual contribution limit for an RRSP is the lower of either 18 percent of your earned income from the previous year or the current maximum annual contribution limit, which as of 2016 is $25,370.
Your RRSP offers up-front tax benefits when you make contributions to the account, whereas a TFSA offers its tax benefits as your funds grow and upon withdrawal. The contributions you make to your RRSP are tax-deductible, reducing your taxable income for the year you when you make the contributions; contributions to a TFSA are not tax-deductible.
However, once the money you contribute to an account begins to grow through investments, the advantages of a TFSA stand out. Money earned in your TFSA account is completely tax-free, while the money earned in an RRSP is only tax-deferred until you withdraw it. Your withdrawals from a TFSA account are also completely tax-free, while your withdrawals from your RRSP are taxable income and may also affect your eligibility for income-tested federal government benefits or tax credits.