Tax Free Savings

Back In 2009 the first modern innovation in financial savings products in a generation emerged onto the Canadian investment marketplace: The Tax Free Savings Account.

TFSAs are an easy to use and relatively convenient tool for saving for a variety of purposes, useful to most all Canadians in most all of our tax brackets.
The TFSA is literally for everyone: anyone over 18 years of age who is a resident of Canada is eligible to contribute to a TFSA
Any type of publicly traded investment can be put inside a TFSA and any capital gains or interest income received is – as the title would indicate – free of taxation. This means anything from T-Bills, Cash, stocks or fixed income investments can be used. While Gains are not subject to taxation, the reverse is also true in that capital losses experienced within a TFSA cannot be claimed for tax purposes.
Contribution room is indexed to inflation and rounded off to the nearest $500 increment; in 2019, the tenth anniversary of the product, the annual limit has been raised to $6,000. This means that the cumulative total for Canadian residents eligible to contribute every year since 2009 is now $63,500. Over contributions are taxed at 1% per month until removed from the TFSA
The TFSA can act as a sort of complement to the more traditional RRSP – the Registered Retirement Savings Plan. Acting as a Rainy-Day Fund or a Special Project Fund it allows Canadian investors to leave untouched their retirement funds in the case of an emergency. What’s more, if an emergency or special project does arrive, the TFSA allows for not only the tax-free accumulation of interest or capital gains, not only their withdrawal and use without penalty, but the rules allow the Canadian investor to replace, dollar for dollar, that which was removed. So, if you managed to invest to the maximum contribution limit since 2009 and you invested wisely and doubled your money to, say, $100,000, you could give it away to your children, lend it out to them to purchase a house, purchase a vacation property in a southern clime, whatever the case may be – and replace that money from another source the following year – plus the new year’s contribution allotment – and resume your accumulation of tax-free earnings.
In the previous segment we took an in-depth look at the features and benefits of the Tax-Free Savings Account (TFSA). We compared and contrasted these features and benefits versus the more traditional Registered Retirement Savings Program, the RRSP. Investing advice has often touted the dual strategy of contributing to both investment options while prioritizing the more traditional RRSP and its tax deferment strategy. But is this necessarily the best option for all investors?
For some investors, it turns out, the RRSP is not necessarily always the best strategy. Young wage earners just getting their careers started and earning a relatively smaller salary (less than about $40,000 per year), may be better served in the long run by foregoing the RRSP deposit in favour of a deposit to their TFSA. Because unused RRSP contributions can be carried forward, the young investor can make up for missed contributions later in life when their income is higher and, therefore, the tax benefit considerably better.
Another option may be to make the RRSP deposit and take advantage of the growth while not claiming the tax benefit until later in life when, again, the investor is presumably earning more money and is in a higher tax bracket. By way of an example, lets take John in Manitoba. John made $35,000 in 2018 and experienced a marginal tax rate of 27.75%. That means that a $3,000 contribution to his RRSP would save him $832.50. Compare this to Helen who made $75,000 and has a marginal tax rate of 37.9%. The same $3000 RRSP contribution saved her $1137 on her taxes (36% more than John). If John is confident that his earning power will increase substantially in his career, he may decide that claiming the larger amount later in life when he is taxed at a higher marginal rate may be more advantageous. Rather than make a RRSP deposit, John may instead deposit the $3000 to his TFSA and take advantage of the tax-free growth of his money in the interim.
Another brilliant and helpful use of the TFSA is to help retired investors reduce their earned income. Because some Canadian government retirement benefits such as Old Age Security (OAS) are what is called ‘means-tested’ it dictates that if you earn a certain amount of money from a pension, interest income or other forms of benefits like an annuity of LIF, you may qualify to receive less money. If you derive an income stream from a TFSA and reduce the income received from registered investments, you may be able to continue to receive more cash or income from these programs while preserving more of the retirement nest egg.
As a death benefit the TFSA continues to live up to its name of Tax-Free: anyone can be the designated beneficiary and this beneficiary can receive the entire proceeds tax-free at the time of death. However, any income earned after the date o death is indeed taxable. A spouse on the other hand can inherit the TFSA account as the designated Successor Holder: even if the Successor Holder has no contribution room of their own left, they may receive the balance tax-free, and transfer it into their own name and continue to earn tax-free gains until their death.