How does a TFSA work?
A tax-free savings account is a registered savings vehicle, where contributions are made with after-tax dollars and withdrawals are tax free. This means that money can be earned in the account and withdrawn at any time without being taxed.
Any Canadian resident over the age of 18 can save up to $5,500 every year in a TFSA. The annual contribution limit was $5,000 from 2009 to 2012, $5,500 from 2013 to 2014, $10,000 for 2015 and $5,500 for 2016, 2017 and 2018.
TFSA versus a non-registered account
Capital gains and other investment income earned in a TFSA are not taxed.
So, if you contributed $5,500 a year for 20 years to a TFSA, you would enjoy a total tax savings of $20,193 over a non-registered account.
Calculating Contribution Room
Here is an example of how to calculate TFSA contribution room;
In 2013, Kim opened a TFSA and contributed the maximum of $5,500. The following year, 2014, she withdraws $2,200 and made no further contributions during 2014, 2015, 2016 or 2017.
In 2018, she can contribute:
$20,000 ($5,000 of unused contribution room for each year from 2009 - 2012)
the $2,200 that was withdrawn in 2014
$5,500 of unused contribution room for 2014 and $10,000 for 2015
$16,500 ($5,500 of unused contribution room for each year from 2016 - 2018)
for a total of $54,200.
Any deposits made during 2018 will be deducted from $54,200. If she does not use up her full contribution room during the year, she can carry it forward to future years.
TFSA vs. RRSP
TFSAs can hold the same investments as other registered accounts, including
But they are different from RRSPs because any amount withdrawn from the account is automatically added back to the contribution room for the following year. Any unused contribution room can be carried forward indefinitely to future years.
TFSAs are more flexible in other ways than RRSPs, which require you to have an earned income and be under the age of 71 in order to make a contribution.
For virtually all savings and investment objectives
Contributions are made with after-tax income
Contributions are tax deductible
Contribution room is added back in the year following a withdrawal
Contribution room is not added back when withdrawals are made
Withdrawals are added to income and taxed at your current rate
No requirement to withdraw at any age
Must be converted to a RRIF by age 71; minimum withdrawals after that age are mandated according to a schedule based on age
Contributions can be made any time for those age 18 and older
Contributions cease at age 71
Annual maximum contribution – $5,500, partially indexed to inflation
Annual maximum contribution – 18% of earned income in the previous year to a maximum of $26,230 for 2018
How taxation can affect your choice
When choosing between a TFSA and an RRSP, one of the main considerations is your client’s current and future levels of taxation.
Generally, savers who expect to have the same or lower tax rates during retirement as during their working years benefit more from the RRSP, while others would benefit more from a TFSA.
Another consideration may be an individual’s eligibility for income-tested benefits such as Old Age Security, the Guaranteed Income Supplement, Canada Child Tax Benefit, the GST/HST Credit and the Age Amount Tax Credit. Unlike income from an RRSP or RRIF, which is included when calculating these benefits, withdrawals from a TFSA do not affect the level of benefits received. It should be kept in mind that every individual faces different circumstances and financial needs.
Want to read more on TFSA vs. RRSP? Click here for a case study.
The CI Advantage
Choosing the right investment
Tax-free savings accounts can be valuable tools in financial planning. They can be used in many ways – for an emergency fund, for short or medium-term savings for a specific purpose, to generate supplemental income, or for long-term investments.
Since TFSAs are an excellent way to save for a house or for future education needs, they can provide a great alternative to tapping into an RRSP.
With a TFSA, investors can:
Top up their retirement savings, beyond RRSP contributions
Save tax free even if they have little or no contribution room in their RRSP (for those over the age of 71, or those with large pension adjustments)
Use a spouse’s or adult children’s TFSA for income splitting
Use a TFSA for estate planning purposes
Talk to your financial advisor
CI Investments has been managing money for over five decades and today is one of Canada’s largest investment fund companies. We provide one of the industry’s widest selections of investment products and leading portfolio managers. With a broad selection of mutual funds, managed solutions and guaranteed solutions, CI Investments has a product to meet every need.
CI is proud to partner with financial advisors across Canada, who offer our funds to their clients. We believe investors are most successful when they follow a sound financial plan developed with the assistance of a qualified advisor.
Talk to your advisor about the best way to incorporate a TFSA into your savings and investment plan.
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