TFSA – How to Use it Effectively!

The majority of people we talk to do not understand how Tax-Free Savings Accounts (TFSA) work or how to best utilize them. This is partly due to how TFSA’s have been marketed by the banks. Here are some key things to know about these valuable tax shelters the government implemented in 2009.

Key factors:

1. Contributions into the plan go in after tax has been paid on the money you earn. A RRSP gives you a tax deduction, whereas a TFSA does not.
2. All of the funds in a TFSA are tax sheltered, as long as the money stays in the plan you do not pay tax on the growth.
3. Withdrawals from the plan are tax free. This includes upon death to your beneficiary.

(Note: There are other details to TFSAs but for the purpose of this article we will not go into all of them as we want to give you a broad overview.)

When to use TFSA’s:

1. Low income earner – A typical rule of thumb is, if your taxable income is less than $50,000 per year, it’s advantageous to use a TFSA instead of a RRSP since your tax payable is already at a lower point on the graduated scale.
2. Pension plan member – For individuals who have defined benefit pension plans such as nurses, firefighters, police, etc., the TFSA is a nice complement since the individual’s RRSP contribution room will likely be small as their pension plan uses up most, if not all of it. Additionally, the TFSA provides tax-free income in retirement and flexibility when redeeming the money.
3. Existing non-registered investments – Often times people have existing investments sitting in non-tax sheltered accounts which they are paying tax on as they earn investment income. A simple strategy can be to move the non-registered funds systematically into a TFSA.

Common mistakes

1. Short term savings – Has a bank teller ever asked you the question, “Have you saved money into your TFSA?” Often we are not sure how to answer this question…Should I? What are they? In an effort to promote TFSAs and get more money into your account, the banks typically promote the TFSA as a short term savings vehicle that you can redeem at any time. While this is true, it is not an effective way to use the vehicle. When you earn very little in interest income, you save very little in tax. For example, a typical “high interest” savings account at the bank currently earns 0.45%. You would be better off using the TFSA for long term savings with higher income earning investments that take advantage of the tax sheltering.
2. Successor holder versus beneficiary – A unique feature of the TFSA is being able to name your spouse or common-law spouse as a successor holder rather than a beneficiary. This means that the investments and the existing tax shelter will go into their name upon the account holder’s death, allowing for tax savings on your estate. The bottom line is that you receive the tax shelter room. In the case of a beneficiary you only receive the money not the tax shelter room.

If you have any questions, please feel free to contact us.

You can obtain more information from the CRA website.