Author: Chris Wiens, MBA, CFP® – Certified Financial Planner®
The TFSA (Tax Free Savings Account) was introduced to Canadians 10 years ago, on January 1, 2009. Last November, the Government of Canada announced that the annual contribution limit for TFSAs would be $500 higher in 2019 (increased to $6,000 from $5,500).
Indexed to inflation, and rounded to the nearest $500, the increased limit for 2019 means the cumulative contribution room available to each Canadian taxpayer who has never contributed to a TFSA in the past (and was 18 or older in 2009) will be $63,500.
As the TFSA contribution limit grows, it becomes a more relevant and powerful investment vehicle for all Canadians, regardless of income. It is flexible and an excellent complement to the RRSP in retirement planning.
Many Canadians are missing out on the benefit of this tax savings tool, mainly because they don’t understand what it is and how to maximize its benefit. As a result, too many ignore or misuse it. It is NOT just a savings account.
Here are some tips to get the most out of your TFSA:
- A TFSA is a great vehicle to build wealth, not just stash your emergency savings. TFSAs can hold stocks, mutual funds and ETFs, not just bonds and GICs – and all growth is tax-free!
- Understand the difference between a TFSA and RRSP, and which is most beneficial given your specific situation and goals. Important factors include: marginal tax rate today vs. retirement (anticipated), purpose of funds, contribution room available.
- In a diversified portfolio that includes both a TFSA and non-registered accounts, hold any Canadian dividend stocks in the non-registered account, not the TFSA. Canadian dividends get preferential tax treatment, which is not as beneficial inside a TFSA. Further, avoid US Dividend stocks in your TFSA if possible. The US government assesses a 15% withholding tax on these dividends to foreign investors. This tax doesn’t apply in your RRSP, so it would be better to receive these dividends in your RRSP.
- Avoid over-contribution! The good news is that withdrawals from your TFSA get added back to your contribution room. However, it isn’t added back until Jan 1 of the following year. A 1% monthly penalty is assessed on over-contributions.
- Income Splitting. There could be a tax benefit utilized when spouses with a higher-income contribute to the TFSA of a lower-income spouse. Benefits could include: lower-income spouse not paying tax on any resulting investment income or gains, no income attribution to spouse who made contribution, and no impact on spousal tax credits.
- A TFSA can be an alternate or complementary education savings vehicle to an RESP. Although not eligible for the government grants and bonds of the RESP, all withdrawals from TFSA can be made tax-free.
- Enhance income in retirement. The TFSA provides a unique investment opportunity in retirement years, provided you are debt-free and pension income leaves you extra cash to invest. You don’t need earned income to generate TFSA contribution room (as an RRSP requires). In addition, you can continue contributions beyond age 71 (which is the cutoff for RRSP contributions), and avoid OAS claw back when you make withdrawals.