For many Canadians, tax-free savings accounts (TFSAs) may be the most advantageous change made to the tax code since RRSPs were launched in 1957. Many professionals even contend that the popularity of TFSAs will ultimately surpass that of RRSPs.
However, despite countless clarifications by Revenue Canada and others, TFSAs continue to be misunderstood. A CIBC poll found that fully 50 per cent of Canadians are unsure what can be held in a TFSA. Most viewed them as savings accounts, and only a small percentage could accurately identity other TFSA investment options like mutual funds, GICs, bonds, or stocks.
TFSAs are pretty straightforward. They are available to Canadian residents 18 years of age or older, and unused contribution room can be carried forward indefinitely. Withdrawals can be made anytime in any amount, without being taxed, and can be fully re-contributed the following calendar year. An investor who has never contributed to a TFSA, but has been eligible since 2009, can invest up to $46,500 for 2016. For those who have maximized their contributions yearly, the 2016 limit is $5,500.
TFSAs are useful for a wide range of investors. They benefit young people who are still in lower income tax brackets and don’t gain much from the tax deductibility of RRSPs. It is more logical for them to accumulate tax-free earnings in a TFSA while saving RRSP headroom until their marginal tax rate is higher.
Investors in higher income tax brackets, who maximize RRSP contributions, can use the refunds to fund TFSA contributions. The invested refund can grow without fear of taxation either now or in retirement, multiplying the positive impact of the original RRSP contribution.
Seniors can also profit. Unlike RRSPs, a withdrawal from a TFSA is not considered income and therefore doesn’t affect eligibility for Old Age Security. Seniors can move their income-producing investments into TFSAs, to prevent or reduce OAS clawbacks.
Families can capitalize on the fact that attribution rules do not generally apply, so individuals can contribute to the TFSAs of other adult family members, effectively splitting income. Such contributions don’t affect individual contribution limits.
Parents saving for their child’s education through Registered Education Savings Plans (RESPs) can benefit from integrated RRSP and TFSA planning. The tax refund received from an RRSP can be contributed to a TFSA where the money can grow tax-free and, at the end of the year, withdrawn to make an RESP contribution.
Those who use TFSAs as saving accounts are not maximizing them because, generally speaking, they should be used for investments offering better growth potential. Compare an investor who purchases an equity product with one who leaves the TFSA in cash. The investor who contributed $5,500 to a TFSA, fully invested in an exchange-traded fund earning 10 per cent for the year, would have a tax-free profit of $550. The investor who left the contribution in cash generating 1.50 per cent only received $82.50. The difference speaks for itself.
– Kim Inglis, CIM, PFP, FCSI, AIFP is an Investment Advisor & Portfolio Manager with Canaccord Genuity Wealth Management, a division of Canaccord Genuity Corp., Member – Canadian Investor Protection Fund. www.reynoldsinglis.ca. The views in this column are solely those of the author.