Just a decade after it was announced by then Conservative Finance Minister Jim Flaherty, the Tax Free Savings Account (TFSA) has become the savings vehicle of choice for many Canadians.
According to the 2016 census, the majority (65.2 per cent) of Canada’s 14 million households contribute to one of the three major types of registered savings accounts – the Registered Retirement Savings Plan (RRSP), registered pension plan (RSP) and the TFSA – in 2015.
Nationally, 40.4 per cent of households contributed to TFSAs compared to 35 per cent to RRSPs and 30.1 per cent to RSPs. Households with a major income earner younger than 35 (40.4 per cent) and those with a major income earner older than 54 (43.1 per cent) were the most likely to contribute to a TFSA.
“I think people have known for some time that the TFSA has been very popular but now the statistics prove it,” says Aurele Courcelles, assistant vice president of tax and estate planning with Investors Group. “It has become one of the country’s most powerful investment vehicles.”
The TFSA has been highly lauded by major Canadian business associations and groups including the C.D. Howe Institute, which stated “this tax policy gem is very good news for Canadians and Mr. Flaherty and his government deserve credit for a novel program.”
In 2015 South Africa introduced TFSA accounts to encourage low- to middle-class citizens to save money.
Canadian residents 18 and older are eligible to open and hold a TFSA account. The account holder may withdraw money from the account at any time tax free and then redeposit the money back into the account in the following year.
The maximum annual contribution room for each year prior to 2013 was $5,000 per year. Beginning in 2013 it was increased to $5,500 per year. This contribution limit was indexed to the Consumer Price Index in $500 increments to account for inflation.
The 2015 federal budget raised the contribution limit to $10,000 and eliminated indexation for inflation beginning with the 2015 tax year. However, in December 2015 the newly-elected Liberal government restored the $5,500 limit for 2016 with the indexation for inflation after that.
As of January 1, 2018 the total cumulative contribution room for a TFSA was $57,500.
The TFSA and RRSP differ in regards to tax treatment and its main purpose. The Canada
Revenue has described the difference as “an RRSP is primarily intended for retirement. The
TFSA is like an RRSP for everything else in your life.”
With an RRSP there is an income tax deduction for contributions and withdrawals of
Contributions and investment income all are taxable. With a TFSA, however, there is no tax
deduction for contributions and there is no tax on withdrawals of investment income or
contributions.
A further advantage is that income and/or withdrawals from a TFSA do not impact
Government pension plans such as the Old Age Security.
While an RRSP must be withdrawn before the holder turns 71, the TFSA does not expire. There
are penalties for withdrawing funds early from an RRSP with two exceptions – for the Home
Buyers Plan and Lifelong Learning Plan – compared to penalties for over contributing
to a TFSA.
Canadians with an income below $80,000 are more likely to use a TFSA. It is particularly
attractive to younger Canadians below 35 years of age because they probably will have lower
incomes and cannot take full advantage of the tax deductions of an RRSP. They can
contribute to a TFSA when they are young, withdraw the money and put it into an RRSP when
their salaries increase as they get older, and then top up their TFSAs.
It’s also popular with older Canadians who have may have no contribution
room left in their RRSPs.
“With its flexibility, a TFSA is a great way to build an emergency fund, save for a specific purpose in the future and for retirement,” Courcelles says. “It is a great adjunct to other retirement savings vehicles.”
Talbot Boggs is a Toronto-based business communications professional who has worked with national news organizations, magazines and corporations in the finance, retail, manufacturing and other industrial sectors.