How TFSA can keep your riches out of the hands of the CRA?
Not everyone can maximise their annual contributions into both TFSA and RRSP. With the Registered Retirement Savings Plan (RRSP) deadline of March 1, 2019 only a couple of days away, you might be left deciding between whether to allocate money to your Tax-Free Savings Account (TFSA) or RRSP.
Challenge is that according to the Bank of Montreal ,thirty-two per cent of Canadians do not understand the difference between TFSAs and RRSPs.
According to a BMO report, there is one clear winner: TFSAs, with over half of Canadians indicating they would pick the investment vehicle. As a result, this article has a primary focus on TFSA as a popular choice. Moreover, there is no deadline for contributions to a TFSA. For more details on RRSP please read : What no one tells you about RRSP.
RRSP vs TFSA
If your income falls into a lower tax bracket now, but you expect it to be higher in future, a TFSA offers a more significant tax benefit because you would pay a higher tax rate on RRSP withdrawals than you will pay today on the income you contribute to TFSA.
Hence, TFSA is popular amongst younger people and those who are in new careers such as students and recent graduates.
“TFSAs are usually better for individuals with modest or low annual incomes.”
The fluid nature of TFSA makes it impossible to establish specific investment guidelines that will be suitable for all plans. You should decide in advance what your primary investment goal will be and choose investments that fit the strategy.
“If you earned $40,000 or less last year would generally get a better result with a TFSA than an RRSP.”
As such your best tax strategy for dividing your investments between TFSA and RRSPs may depend on any differences between your current tax bracket and one you expect to be in when you start withdrawing funds from your RRSP.
With a TFSA, you don’t pay any tax on what you earn while your money is in the plan – or when you take it out. You don’t have to open an account or even file a return to accumulate TFSA contribution room.
If you are 18 or older in 2009, and have lived in Canada since that time and never contributed to a TFSA, you have a total of $63,500 of TFSA contribution room.
Assuming you have TFSA contribution room, it almost always makes sense to invest in TFSA if you have money sitting in a bank account earning taxable interest.
Whether you’re investing in mutual funds, ETF’s, stocks, GIC’s, etc., these investments are going to grow beyond the net amount you contributed to purchase them, and that growth is most definitely taxable except when the investments are held within a TFSA! As a result, you’ll be able to sell that investment later, pay no tax on any capital gains, and withdraw those proceeds tax-free.
The privilege to earn tax-free gains is wonderful but any losses incurred cannot be claimed.
The limit has been increased to $6,000 for 2019 from $5,500 in 2018. So if you can resist the RRSP hype and put your money in TFSA, you have a larger limit than you did. With TFSA it is not “use it or lose it”situation, as the unused contribution room is carried forward into the next year.
A TFSA Withdrawal in any year does not increase the TFSA room until the following calendar year.
TFSA for short term use
If you’re looking to save to get a return within roughly one to three years, such as for a new car, a marriage, an upcoming vacation or a renovation, or maybe to build an emergency fund, a TFSA (Tax-Free Savings Account) can be the ideal solution.
Unlike the RRSP, which you use for retirement savings. A recent BMO survey found that TFSA can be used for anything, only 50% of Canadians are using a TFSA for long-term savings. Another 40% said they’re using it as an emergency fund.
It’s not clear what the other 10% are using it for, but making a quick buck is probably a good guess.
Source : Anticipated Sources of Retirement Funds Cited by Respondents in CIBC Retirement PollTFSA for Seniors
Unlike an RRSP, which has to be wound up when you reach age 71, you can maintain your TFSA for your entire life, and so your TFSA should be integrated with your retirement income plan.
So, TFSA may be a great option if you are still hoping to save money in a tax-sheltered environment. The statistics support his insight.
Baby Boomers lead the charge on TFSAs: Since 2014, the gap between Canadians choosing a TFSA over an RRSP has risen to over 20 per cent. Sixty-nine per cent of those 55 and over would choose a TFSA over RRSP.
TFSA can make you a millionaire
TFSA helps you enjoy the full benefit of compounding. The beauty of compound interest is that it allows you to earn interest on your interest – so that while you have to sweat to make money, you initially invest, from then on your money works on your behalf. Compounding is like a rolling snowball. It takes time to gather speed and mass. The more years a plan has to grow, the more impressive the returns will be.
The sooner you begin contributing to TFSA, the more effectively a TFSA can work for you.
Compound interest is the greatest invention the world has produced -Albert Einstein.
In case you are wondering, assuming an annual compound rate of return of 5%, it will take 45 years for the value of the plan to surpass $1 million based on your annual contribution of $6000. With life expectancy increasing, if you are 30 today(or younger), you have a realistic hope of achieving that $1 million. Also, remember if your spouse also contributes to TFSA, you can save twice as much.
TFSA for your spouse
There is no such thing as spousal TFSA, unlike the situation with RRSP. Each persons TFSA is his or her own.
TFSA for buying a house
If you plan to buy a house, you can use a TFSA(although the first choice is always RRSP) to add to your house savings.
If you don’t qualify for the HBP because you or your spouse has owned a home within the time frame, a TFSA is undoubtedly a worthwhile alternative.
TFSA as a collateral
Unlike RRSP, A TFSA can be used as collateral for loans. This could be useful as collateral for loans.
This could be useful in a situation where you suddenly need cash to deal with an emergency, but the money in your TFSA is not accessible, perhaps because it has been invested in a locked GIC.
If your lender is satisfied that the assets in the plan are sound, the TFSA can serve as collateral for a cash advance.
The Canada Revenue Agency (CRA) has been paying particular attention to TFSA over contributions. Any profits made on income earned from over gifts will be fully taxed. The tax is calculated based on the highest excess amount for the month and, unlike registered retirement savings plans (RRSP), there is no $2,000 grace amount.
Also, over contributions attracts draconian interest charges (12% per annum), so do not over contribute.
TFSA and RESP
If you are saving for your child’s education, keep in mind that, unlike a TFSA, an RESP (Registered Education Savings Plan)offers an annual guaranteed rate of return of $500(20% on yearly contribution) via the federal government’s Canada Education Savings Grant which is merely free money for the taking.
The matching CESG is subject to both annual and lifetime maximums. Our advice is to open and contribute $2500 RESP contribution as soon as you can in the year of your child’s birth.
After that, make additional $2,500 contributions in early January of each year to receive the grant as soon as possible and make that cash working for you (it typically takes 6-8 weeks for the $500 grant to ‘arrive’ into the RESP account). You can enjoy tax-free growth on your investment in RESP.
Once your children turn 18, you may want to consider giving them funds to out into their TFSAs to help finance their post-secondary education.
Repayment of Debt vs Investing in TFSA
The election between a TFSA contribution and debt repayment, both of which are “after-tax” investments, depends singularly on the rate of return on investments versus the interest rate on debt.
If the rate of return on investments is higher than the rate of interest on the debt, a TFSA returns a higher benefit; otherwise, debt repayment is a better choice.
For example, if your mortgage rate is 3.50%, but you can only earn 3.20% within your TFSA, you would be better off using the $6,000 against the mortgage principal immediately rather than waiting.
TFSAs for building assets
One of the fastest ways to build assets in a TFSA is to use a self-directed plan to hold shares of a small business with high growth potential. This strategy is heavily regulated and is off the table if you own 10% or more of the company or do business with it on a non-arm’s-length basis.
Investing allows your money to make money. But making more money means paying more taxes, so if you’re looking to skip the tax part of this equation you’ll put those investments in a TFSA and keep your riches out of the hands of the CRA!
Your CPA can help you understand the tax rules to ascertain that you get the most out of your retirement dollar.
Happy 10th birthday to the TFSA.
Citations
“TFSA vs. RRSP: Over 30 Per Cent of Canadians Don’t Know the Difference, Finds BMO Study.” Yahoo! Finance, Yahoo!, 21 Feb. 2019, finance.yahoo.com/news/tfsa-vs-rrsp-over-30-130000955.html.
Cibc.com. (2019). [online] Available at: https://www.cibc.com/content/dam/personal_banking/advice_centre/tax-savings/retirement-income-tax-en.pdf [Accessed 27 Feb. 2019].
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