The Benefits of a Tax-Free Savings Account (TFSA)

In 2009, the Federal Government introduced the Tax-Free Savings Account (TFSA), describing it as “the single most important personal savings vehicle since the introduction of the Registered Retirement Savings Plan (RRSP)."

The TFSA undoubtedly allows our clients to set money aside in eligible investment vehicles and to watch their savings grow tax-free throughout their lifetime. TFSA savings can be used for any purpose — to purchase a new car, take a vacation, renovate a house or even start a small business. Also, Canadians of all income levels and from all walks of life can reap the benefits.

This summary gives you an idea how the TFSA works:

Since 2009, any Canadian resident aged 18 and older can save up to $5,000 every year in a TFSA.
Your contributions to a TFSA are not deductible for income tax purposes but the investment income, including capital gains, earned in your TFSA is not taxed, even when withdrawn.
Your unused TFSA contribution room is carried forward and accumulates for future years.
You can withdraw funds available in your TFSA at any time for any purpose — and the full amount of withdrawals can be put back into your TFSA in future years.
Neither income earned in a TFSA, nor withdrawals, affect your eligibility for federal income-tested benefits and credits.
You can provide funds to your spouse or common-law partner to invest in their TFSA.
TFSA assets can generally be transferred to a spouse or common-law partner upon death.
On the breakdown of a marriage or common-law partnership, any amount may be transferred directly from the TFSA of one party to the TFSA of the other.

Not everyone is able to save each and every year, depending upon his or her economic situation. Since your annual contribution amount is cumulative, if you miss putting $5,000 into the account one year, then you are eligible to put $10,000 into the account the following year. There is no limit to the number of years that the unused contribution room may be carried forward. Additionally, if you withdraw from the account in a given year, the withdrawal amount is added back to your contribution amount so you can reinvest it at a later date.

Couples often save and plan together, so individuals can provide funds to their spouse or common-law partner to invest in their TFSA, up to the spouse’s or common-law partner’s available room.

Another of the many benefits in saving in a TFSA is that capital gains and other investment-income earned in a TFSA are not taxed — even when withdrawn (either as they accrue or when they are withdrawn) — so 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.

How is a TFSA different from a Registered Retirement Savings Plan?

An RRSP is primarily intended for retirement, while  the TFSA is like an RRSP for everything else in your life.

Both plans offer tax advantages by allowing you to accumulate investment income tax-free within the plan or the account, but they have key differences:

• Contributions to an RRSP are deductible and reduce your income for tax purposes. In contrast, your TFSA savings contributions are not deductible.

• Withdrawals from an RRSP are added to your income and taxed at current rates. Your TFSA withdrawals and growth within your account are not included in your income — they are tax-free.

Here is an example of how a TFSA is an effective vehicle for your lifetime savings needs:

Jim withdraws $20,000 tax-free from his TFSA to renovate his home. He will be able to re-contribute the $20,000 to his TFSA in the future without affecting his other available contribution room. Had Jim used his RRSP savings, he would have needed to withdraw up to $37,000 to pay taxes and cover the cost of the renovation, and this contribution room would have been lost.

Our clients can also benefit by using the TFSA to start saving early for future needs and goals. It is worth noting, too, that the TFSA will provide seniors with a tax-free savings vehicle to meet ongoing savings needs, even after they reach age 71 and are required to convert their registered retirement savings into a retirement income vehicle.

Any questions concerning the above should be directed to John Dow, Tax Partner —jdow@sbpartners.ca or (905) 632-5978

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