Tax Free Savings Accounts (TFSAs) have generated a lot of interest since they arrived on the Canadian savings scene just over a year ago. This is with good reason – because as the name implies, all the money you earn in a TFSA is tax-free.
To start a TFSA, you must be 18 years of age or older and have a social insurance number. Then each year, you can add up to $5,000 to the plan – more after the first year, if you have unused contribution room. Beginning in 2011, that $5,000 limit will be indexed to inflation and rounded to the nearest $500, meaning the contribution ceiling will go up or down in $500 increments when the value of the money justifies it.
“Before you put your money in a TFSA, be clear about your objectives,” says Chartered Accountant Kevin Ball with Edmondson Ball Davies LLP in Toronto. “Different goals need different strategies. The approach should be different if you’re interested in short-term savings – maybe to renovate a house or take a vacation – as opposed to a long-term plan, like saving for retirement.”
“From a tax planning point of view, I would recommend that people maximize their RRSP contributions first and use the TFSA to supplement their savings,” says Corey Houle, CA, principal at Freelandt Caldwell Reilly Chartered Accountants LLP in Sudbury. “Money you put into an RRSP is tax deductible, so you are earning investment income on your pre-tax dollars. The idea is to withdraw the funds in a year when you are in a lower tax bracket so that the amount of tax you pay is lower. With TFSAs, you’re investing after-tax dollars.”
Houle adds that there are many situations and circumstances in which TFSAs make a lot of sense.
“With a TFSA, you can earn money and have the funds available at any time,” he says. “This makes sense for people over the age of 71 who are no longer eligible to contribute to an RRSP. TFSAs are also a good option for people who have maxed out their RRSP contribution room, because they can be used to buy stocks, bonds, mutual funds or other kinds of investments. The capital gains or income generated is tax-free.”
While those in middle and higher income brackets are able to make contributions to both an RRSP and a TFSA, it is often advised that lower income people use a TFSA if they can afford to contribute to one form of savings.
“Once the TFSA is established, you can carry the contribution room forward indefinitely,” says Ball. “When you withdraw the funds, you get all the contribution room back in the following year, as well as any incremental room you may have created due to interest or earnings. What you can’t do is deduct any losses on your investments, use losses to increase your contribution room, or deduct any of the fees that may be associated with setting up the plan.”
Another bonus is that earnings or withdrawals from TFSAs don’t affect other government benefits, like Old Age Security, Child Tax Credits or Guaranteed Income Supplements – something that’s not necessarily the case with RRSPs.
“As with RRSPs, couples can income-split without any attribution of income or gains, and TFSAs can generally roll-over to a spouse upon death,” says Ball.
TFSAs can be used to house an “emergency” fund – that cash reserve we’re all supposed to keep on hand in case of emergencies. The money is there if we need it, yet still working for us if we don’t.
The Institute of Chartered Accountants of Ontario is the qualifying and regulatory body of Ontario’s 33,000 Chartered Accountants and 5,000 CA students. Since 1879, the Institute has protected the public interest through the CA profession’s high standards of qualification and the enforcement of its rules of professional conduct. The Institute works in partnership with the other provincial Institutes of Chartered Accountants and the Canadian Institute of Chartered Accountants to provide national standards and programs that are used as examples around the world. </em>
