In our last blog post we wrote about the reasons to invest in an RRSP, this time we’ll be taking a look at Tax-Free Savings Accounts (TFSA).
What is a TFSA?
A TFSA is a registered savings vehicle that allows Canadians to earn tax-free investment income. The TFSA is not a specific product (like a savings account); rather, it should be thought of as a plan (kind of like an RSP) that is capable of storing different types of investment products (E.g., investment funds, securities, GICs, etc). Unlike an RSP which, is generally intended for retirement (though, as noted in our last blog post RSPs do have other uses), a TFSA lets you save tax-free for any goal you want (I.e., you can use your TFSA savings to buy a new car, do some home renovations, start a business, etc). Note: The TFSA has been called the most significant personal savings vehicle for Canadians since the RRSP (which was introduced in 1957).
The TFSA can act as a standalone investment strategy or it can be used to complement existing income sources (I.e., pension plan) or registered savings plans like the Registered Retirement Savings Plans (RRSP) and/or the Registered Education Savings Plans (RESP). Even if you save only a little each year, you should strongly consider saving some of your money in a TFSA (especially unregistered savings).
Some TFSA Key Facts include:
- Canadian residents aged 18 or older are allowed to contribute up to $5,000 annually to their TFSA with “catch-up” provisions allowed
- The Canada Revenue Agency will advise you each year of your current TFSA contribution room
- You can withdraw money at any time without tax penalty (Note: In some instances, fees may apply)
- Unlike an RSP contribution, there is no tax deduction allowed on your personal taxes for contributions made to a TFSA
These are only a few facts about the TFSA; there are additional specifics that you can read about on the Government of Canada website.
Comparing TFSAs and RRSPs
- Unlike RRSPs, TFSAs do not need to be converted to a RRIF or annuity by December 31st in the year you turn 71
- TFSA withdrawals aren’t considered as income; as such they do not affect your eligibility for programs like the Guaranteed Income Supplement and will not result in an Old Age Security claw-back
- In theory, RRSPs and TFSAs both produce a similar degree of tax efficiency (if you retire in the same tax bracket as when you contribute); however, if your tax bracket will go down in retirement, deferring taxes by using RRSPs will help more than a TFSA
- There is no maximum age for making contributions to your TFSA, thus allowing seniors to continue to save money in retirement
Hints and Tips
- Canadians with a number of sources of retirement income (E.g., employer pension, RRIFs, etc…) may find that the required withdrawals from their RRIF may put them in a position where they are taking out more money than they require (this could put them into a higher tax bracket). While TFSAs are not able to help with the immediate tax burden, the TFSA is able to provide a tax shelter for future investment income
- Tax Free Savings Accounts are not subject to taxes upon death, and should be used as a valuable estate planning tool
- If you hold the bulk of your investments in capital gains or dividend paying securities (I.e., investment funds, stocks, bonds), placing some funds in a TFSA offers an opportunity for maximum growth
- If you hold the majority of your investments in interest-bearing products (I.e., savings accounts, GICs), by holding them within a TFSA you can avoid paying tax at the highest possible tax rate
- Depending on your age, it might be challenging to try and determine which account to put your retirement money in to (especially if you are young). When in doubt you could consider contributing to the TFSA first (you can always withdraw from your TFSA and contribute to your RRSP later on)
Note: There is a lot of information here to digest, if you have any questions please contact me directly or talk to one of our advisors, they would be happy to discuss the different alternatives that exist.
P.S.: As indicated in the last blog (Reasons to Invest in an RRSP), we are aware that each person has their own unique situation and considerations. Next time we’ll take a look at Annuities.
