Canada’s Tax Free Savings Accounts (TFSAs)
November 21st, 2009 | by admin |One of the hottest products for Canadian Financial Planners over the past year has been the Tax-Free Savings Accounts (TFSAs). We’ve had some good discussions with Canadian Financial Advisors on TSFAs, and put the following summary together as a result.
Canadians are rapidly gaining awareness of an attractive new savings vehicle: the Tax-Free Savings Account (TFSA). A TFSA is simply a tax-exempt savings account which is available to any individual aged 18 and over. The maximum contribution is $5,000 a year. Unlike RRSPs, TFSA contributions are not tax-deductible, and the investment earnings are not subject to income tax. Any unused TFSA contribution room can be carried forward, and amounts can be withdrawn at any time. So in many ways, TFSAs are RRSPs in reverse. Instead of giving tax deduction for contribution and making all withdrawals taxable, the TFSA offers no deduction for deposits, but no tax of any kind will be imposed on future investment returns.
TFSA Benefits
The magic behind the TFSA is in its versatility. It is not simply a tax measure designed to help low-income Canadians, but rather a vehicle that can benefit almost every Canadian, regardless of income or stage in life.
For seniors, the plan provides an additional savings device free of tax. This will be an attractive channel to continue saving beyond the current cut-off age of 71 for making RRSP contributions. Moreover, upon the death of the TFSA account holder, assets can be transferred to a surviving spouse or child (or in fact anybody), tax-free without affecting the recipient’s contribution room. For high earners who find that their RRSP contributions are restricted by the current limit of $20,000, this is a welcome addition to contribution room. For the nearly 40% of paid workers who are covered by a registered pension plan, TFSA provides a way to compensate for the pension adjustment that limits RRSP contributions. So in many ways the TFSA can be viewed not as a rival but rather a companion to the RRSP in Canada’s financial landscape.
The TFSA’s flexibility also makes it ideal for immediate needs such as emergency funds as well as a tax-effcient way for Canadians to finance consumption. The account can be accessed multiple times during one’s lifetime to serve as emergency funds, and to bridge periods of income volatility. This liquidity feature of the TFSA plan is of great importance as it will probably work to limit or even eliminate uneconomical behaviour such as RRSP withdrawal. In fact, the liquidity feature is viewed by Canadians to be as important as the tax-free feature in the decision to open a TFSA.