In 2009, the government of Canada introduced the Tax-Free Savings Account (TFSA). The idea was to give Canadians the best opportunity to reach their savings goals, by allowing them to set money aside in eligible investment vehicles and have their investments grow tax free.
A TFSA is now one of the most versatile financial planning tools. It is an effective instrument for short-term goals, such as emergency savings or a down payment, or long-term goals such as supplementing retirement income or other estate planning objectives.
Here are some questions to consider when determining if a TFSA is right for you:
- What age can I start saving within a TFSA?
As soon as you turn 18 years of age and are a resident of Canada with a valid Social Insurance Number, you are eligible to accumulate contribution room for a TFSA. That being said, you are not able to utilize this account until you satisfy the legal age of majority in your province – 19 years old in Ontario and British Columbia, for example.
- What are the rules around contributions?
The maximum contribution room depends on the year you became eligible to contribute. If you were born in 1991 or earlier – so at least age 18 or older in 2009 (the year in which TFSAs was first introduced) – and haven’t previously contributed, your eligible contribution room is $75,500. However, if you turned 18 in 2019, the maximum amount you can contribute is based on the annual limits from 2019 onward, or $18,000. The table below outlines the contribution limits by year.
All unused TFSA contribution is carried over from previous years. As an example, someone who turned 18 in 2019, but didn’t contribute in 2019 and 2020, can deposit a lumpsum of $18,000 in 2021. Additionally, any withdrawal amounts are added back to your contribution room the following calendar year.
An important note for contributions: if you over contribute your TFSA limit, the government can tax your account as much as 1% every month the excess amount stays within your account.
- What is the difference between a RRSP and a TFSA?
Investing within your Registered Retirement Savings Plan (RRSP) has a contribution limit of 18% of your earned income, or a maximum of $27,230 for 2020. If you earned more than $155,000, your RRSP ceiling will be maximized. Once you have maximized your RRSP, contributing to your TFSA is the next best thing to boost retirement savings. *
Investing within a TFSA does not lead to tax deductions like an RRSP; however, withdrawals are not counted as income, withdrawals can happen anytime, and any withdrawals made can be replaced the next calendar year, making it a more flexible investment vehicle. Moreover, in order to contribute to an RRSP you need employment income, while a TFSA has no income requirements.
It is important that you are receiving prudent financial advice, which can help determine how you should delegate your savings and which investment accounts you should be incorporating in your financial plan.
- Can I deposit into a TFSA for my spouse?
You cannot directly contribute to your partners or anyone else’s TFSA; however, you can gift the money to the person, so they can contribute to their own TFSA account. There are no attribution rules and the gifter will not be taxed differently.
- How can I earn more on my investments without increasing risk?
When it comes to investing, taking on more risk means two things:
- Higher return potential
- More portfolio volatility
A TFSA can be used to shelter investments that potentially bring higher returns, or assets that could be taxed at a higher rate. By investing within a TFSA, the investor keeps all the money earned as the tax that is generally paid as interest income and capital gains will be avoided. By not having tax affect the overall net of your return, you are essentially earning more.
- How to take advantage of my RRIF or LIF surplus?
Once retired you will be required to withdraw from your registered retirement accounts (RRSP, LIRA) in the form of a RRIF or LIF and, depending on minimum withdrawal requirements, you may be required to pull more income than you need. To take advantage of this excess capital, you can roll the surplus income into a TFSA where it can grow tax-free.
- How can a TFSA be used to reduce passive corporate income?
Too much passive income within a corporation may have tax implications, especially if the corporation’s small business tax rate is lost. Through a careful understanding of tax and financial planning, taking money out of a corporation, at the right time, may be an ideal strategy. Though the money will be taxed, it will be available to be invested invest within a TFSA.
- Can I leave the TFSA assets to my surviving spouse or family?
Yes. TFSAs are very important in estate planning since the assets may be passed to the beneficiary tax-free. One way of doing this is naming a successor on your TFSA, so that they will replace you as the account holder upon death. Moreover, you can opt to name whomever and whatever beneficiary on your TFSA. An important note, there may be tax implications on earnings from day of death to when account is closed.
To close, only about 10% of all TFSA holders have maxed out their TFSAs, and 42% of people make no contributions at all. At Ciccone McKay, we can help you define the best use of your TFSA in order to build a balanced financial portfolio. If you would like to learn more about TFSAs, or hear how you can maximize their benefits, call us at 604-688-5262 or email us at email@example.com.
*While RRSPs do offer tax-deferred growth, contributing or maxing out an RRSP is not right for everyone depending on their current financial circumstance. Which is why taking advantage of an TFSA becomes even more important due to the tax-free characteristics it provides. Speaking with an advisor will help determine the split between TFSA and RRSP investing.