The Tax Free Savings Account (TFSA) offers Canadians a significant opportunity to develop a tax free income and is another retirement planning option to the older and better-known Registered Retirement Savings Plan (RRSP).
“People should definitely not overlook the TFSA because it provides a significant opportunity to build a tax free income,” says Dave Ablett, director of tax and retirement planning with Investors Group.
Since they became available in 2009, about 6.7 million Canadians have opened TFSA accounts, which now have total assets of about $43 billion.
The TFSA allows holders to contribute up to $5,000 a year.
This is the fourth year of the accounts, meaning that at the start of the year you could have put up to $20,000 into your account.
Unlike RRSPs, there is no tax deduction for contributions to a TFSA.
RRSP contributions are deductible and reduce your income for tax purposes.
However, the money you contribute to your TFSA and growth through interest, dividends or capital gains are not taxable, except for any foreign tax on foreign investments. As well, your withdrawals are tax free.
Money in a TFSA can be invested in the same instruments as an RRSP such as stocks, bonds, GICs and mutual funds. Any unused contribution room can be carried forward, and if you withdraw money in one year from the account, you are allowed to put it back but only in the year after it is withdrawn.
The federal government has promised to increase the yearly contribution limit to $10,000 when it balances the budget, giving Canadians an even greater opportunity to save for their retirement.
The TFSA has a number of benefits, particularly for seniors.
Money from a TFSA is excluded from income-tested benefits and tax credits such as the GST credit and the Old Age Security and the Guaranteed Income Supplement and will not reduce those benefits.
Unlike an RRSP, you can contribute to a TFSA after the age of 71. You are not allowed to contribute to an RRSP after the age of 71, which must be collapsed at the end of your 71st year.
As well, you can pass on your TFSA when you die.
Only a spouse or common-law partner can be named as a successor holder, and upon the death of the TFSA owner the successor holder immediately becomes the new owner of the TFSA.
If the spouse is named the beneficiary of the TFSA, they can elect to transfer the assets at the owner’s death to their own account without affecting their contribution room. Any TFSA income earned after the death of the TFSA owner is taxable to the spouse.
Another benefit of the TFSA is that you can assign assets in your account as collateral for a loan, something you are not able to do with an RRSP.
There is some confusion among Canadians about TFSAs. Some recent studies have found one of the main reasons Canadians have not opened a TFSA account is that they don’t fully understand how they work.
As well, many people still are not aware that the accounts can hold more than simply cash and savings, a fact that some financial experts have said indicates the TFSA may be misnamed as a “savings” account.
The TFSA has appeal for people in their prime accumulating years, those who are actively building retirement assets and for low-income earners who can’t take full advantage of tax deductions from contributing to an RRSP.
It will particularly benefit individuals who will need access to funds before their retirement, and those with little or no room to contribute to their RRSPs.
“Even if you haven’t put anything into a TFSA, as of January this year you have $20,000 of contribution room and, at current contribution levels (of $5,000 a year), you could save another $100,000 over the next 20 years,” says Ablett. “That’s a pretty significant opportunity to build a tax free income.”
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.