Making The Tax-Free Savings Account Fit For Your Life

As of January, 2009, Canadians have a new tax-free option for saving – the Tax-Free Savings Account (TFSA). TFSAs are a flexible investment vehicle into which you can make non-deductible contributions (up to $5,000 per adult in 2009) that will grow and can be withdrawn without incurring taxation. Withdrawals can be made at any time for any purpose. Unused contribution room can be carried forward indefinitely and any amounts withdrawn in a year will be added back to your contribution room in the following year.

So, how you use your tax-free TFSA dollars is totally up to you. But it’s a good plan to ‘fit’ your TFSA investment uses to your life stage. Here are some tips.

Young adults and young families

• Save for emergencies and large short term expenses -- like a vehicle, vacation or home down payment without having to liquidate investments and paying taxes on the income.

• Save for a home – in addition to or in place of the RRSP Home Buyers Plan.

• Save for education – in addition to or in place of non-registered savings, the RRSP Lifelong Learning Plan or RESPs.

• Save for your children – as a parent, you retain control of TFSA funds and when to disburse them.

• Save to start a business – TFSAs are a tax-effective way to save the initial equity you need and can be used as security for bank financing.

• Save for retirement – in addition to your RRSP contributions.
  

Mature adults

• Save for emergencies, large short term expenses and retirement, in addition to RRSPs.

• Save your tax refund – contribute your RRSP tax refunds to your TFSA.
  

Retirees

• Save for emergencies and large short term expenses.

• Shelter excess income from future taxation – if your combined retirement income (from RRSPs, pension, OAS and CPP) is more than you need to live on, build up a non-taxable reserve in your TFSA.

• Build retirement savings after RRSPs – you can’t contribute to an RRSP after age 71, but you can still invest in your TFSA.

• Build a tax-free inheritance for children – a TFSA can be transferred to a surviving spouse/common-law partner without affecting their TFSA contribution room. On the death of the second spouse, the children may inherit the total amount tax-free.

Your professional advisor can help you make the most of your TFSAs and other investments, at every life stage.

Does A Tax-Free Savings Account Fit Your Retirement Plan?

Is a TFSA a good addition to your retirement planning? Yes, when you make it a part of your overall financial plan that includes your most important tax-saving, income-building investment – your Registered Retirement Savings Plan.

Here’s a quick comparison of the TFSA and an RRSP:

• RRSP contributions provide an immediate tax benefit because they are directly deductible from income. Contributions to a TFSA cannot be claimed as a tax deduction.

• Withdrawals from a TFSA are not taxed when withdrawn. RRSP withdrawals are added to income for tax purposes.

• The maximum yearly investment in a TFSA is $5,000 (although you can have more than one Account as long as you do not exceed the $5,000 limit in total). The RRSP contribution maximum is determined by your earned income. (In 2009, the maximum RRSP contribution limit is $21,000.)

• Generally, the same investments are ‘eligible’ for either a TFSA or RRSP – mutual funds, publicly-traded securities, government bonds, GICs, and segregated funds.

• TFSA funds can be withdrawn at any time for any purpose. RRSP funds are typically not withdrawn until after retirement.

• Withdrawn amounts can be put back into a TFSA without reducing contribution room.

• Unused TFSA and RRSP contribution room can be carried forward to future years.

• Withdrawals and income earned in a TFSA will not affect eligibility for federal income-tested benefits and credits including, the Age Credit, Old Age Security benefits or Guaranteed Income Supplement.

• There is no time limit at which a TFSA must be wound up or converted to a different investment. RRSPs must be wound up or converted by the end of the year when a person reaches age 71.

In retirement planning, a TFSA can be a good option:

• When your RRSP is maximized. Because the income is not taxed, a TFSA will likely deliver better returns over the long term than other non-registered investments – but the tax-sheltered, tax-saving, compound growth features of an RRSP still make it a much better choice for long term growth.

• As an incentive to save that ‘little extra’ for retirement, especially for those with modest means because the savings will not reduce income-tested benefits.

Is a TFSA in your future? Your professional planner can help you answer that question in the most profitable way.

The Tax-Free Savings Account – Wow! Or Wow?

Last year in the 2008 Budget, the Federal Government introduced the ‘next big thing in tax reduction’ -- the Tax-Free Savings Account (TFSA. The TFSA became effective in 2009 and the question is: Just how much of a ‘Wow’ is the TFSA for everyday Canadians?

The government hails it as ‘the single most important personal savings vehicle since the introduction of the Registered Retirement Savings Plan (RRSP)’* and estimates that ‘a person contributing $200 a month to a TFSA for 20 years will enjoy additional savings of $11,045 compared to saving in an unregistered account.’*

That’s because a TFSA will allow you to use your savings to invest in eligible investment vehicles and the capital gains and other investment income earned in your TFSA will not be taxed. Here’s how it works:

• Starting in 2009, any Canadian over 18 years of age can save up to $5,000 each year in a TFSA.

• A person may have more than one TFSA but cannot exceed the $5,000 limit in total.

• ‘Eligible’ investments are generally the same as those allowed in an RRSP.

• Unlike RRSP contributions, which are deductible from income and reduce taxes, TFSA contributions do not qualify as deductions.

• Investment income, including capital gains, earned in the TFSA will not be taxed, even when withdrawn.

• TFSA funds can be withdrawn at any time for any purpose – from buying a new car to starting a business.

• Withdrawn amounts can be put back into a TFSA without reducing contribution room.

• Unused TFSA contribution room can be carried forward to future years.

• Neither income earned in a TFSA nor withdrawals will affect eligibility for federal income-tested benefits and credits – such as the Canada Child Tax Benefit, Age Credit, Guaranteed Income Supplement and Employment Insurance Benefits.

• Contributions to a spouse’s TFSA are allowed.

Investment experts suggest that a TFSA may deliver better after-tax value than some non-registered investments, certainly over longer terms. On the other hand, the experts also point out that what is ‘eligible’ for a TFSA and what is ‘suitable’ are two very different issues. For example, an investor may make very conservative – meaning low-earning -- choices for a TFSA because capital losses on more speculative investments will not be deductible – but that strategy may not be consistent with the investor’s overall financial goals and objectives.