The TFSA, a savings tool for everyone!

BY ANDREW STEWART

Saving requires discipline, so it’s essential to choose a reliable method and strategy. Why should you be interested in the Tax-Free Savings Account (TFSA)? It’s a valuable aid to your financial plan when you have a complementary savings tool with almost unlimited flexibility. The Tax-Free Savings Account is the biggest innovation to encourage personal savings since the creation of the Registered Retirement Savings Plan (RRSP) by the government of Canada. Like the RRSP, the TFSA has some impressive characteristics of its own. Interest earned accumulates tax-free, the contribution room is equally fair cause its the same for everyone, cumulative and is not linked to individual income.

This contribution room is available for anyone age eighteen and older starting in January 2009. If you never opened a TFSA before, the total cumulative contribution room in 2020 is $63,500 based on the per-year maximum contribution limits on the CRA website. Another definite advantage of the TFSA is the recovery of the contribution room following withdrawals. That means any amount withdrawn over the year will be added back to the contribution room for the following year. An absorbing and a little known strategy is that the TFSA is a good income-splitting tool. Income splitting is just one of the ways to lower a household’s tax liability. Income splitting works best if one spouse earns significantly more than the other spouse does. This lets the higher-income spouse shift some of their income to the lower-income spouse (whether they are married or common-law). The tax rules allow a higher-income spouse to give the lower-income spouse cash to contribute to their TFSA. There are no tax deductions for contributions to a TFSA, but once the funds are invested, they grow tax-free, can be withdrawn tax-free, and will transfer tax-free to a beneficiary. A parent could do the same with their child (as long as the child is at least eighteen years old).

TFSA or RRSP?
To effectively select which is the best choice between an RRSP and a TFSA, the tax rates during your active life and retirement must be taken into account. Here are three simple rules to help with making that choice. If your tax rate at the time of contribution is higher than what your tax rate will be when you withdraw then an RRSP would be more beneficial. If tax rates are equal, then both the TFSA and RRSP equally beneficial. If your tax rate will be higher at the time of withdrawal, then the TFSA is more beneficial.

So, what are some other main differences between these two savings programs?

You have to be eighteen to open a TFSA and there is no age of eligibility to open an RRSP. That’s right a minor can set up an RRSP with the consent of their parent or legal guardian. But the child must have a job and must have earned an income and gotten a T4 from their employer in the previous tax year. So, if your child is still in diapers, an RRSP is likely not an option.

There is also an age limit for how long you can contribute. That age limit is age 71 for the RRSP and none for a TFSA.
Withdrawals and contribution room can be recovered in full when sums are withdrawn with the TFSA, but all contribution room is lost when sums are withdrawn with an RRSP.

You can use your TFSA as loan collateral. Yes, it’s a little-known fact but it’s true. You can use the assets inside your TFSA as collateral for a loan (whereas you can’t with an RRSP). This can come in handy if, for example, you have money tied up in your TFSA inside a locked-in GIC: you can’t unlock it, but you can use it as collateral.

If you’re interested in finding out more about TFSAs (and there is more to know), feel free to talk to an advisor.