In 2009, the Canadian government introduced a Tax-Free Savings Account (TFSA) as a new, tax-sheltered investment account for Canadians. According to a recent BMO survey, about 44 percent of Canadians are currently using a TFSA. Despite this, many of them are still confused about exactly how TFSAs work - and how they differ from RRSPs.
Here, we'll take a look at a few things you probably don't know about your TFSA - and set the record straight.
1. A TFSA can be used for retirement
A TFSA does not work like an RRSP, but that doesn't mean that it isn't a good bet as part of your retirement plan. In fact, depending on your situation, the TFSA has some major benefits an RRSP can't match. For starters, unlike RRSPs, withdrawals from TFSAs are tax-free. This can be important for retirees who may be in a higher tax bracket when they retire than when they were working (which, let's face it, would be a fabulous problem to have). In this case, a TFSA can provide access to cash without boosting taxable income. TFSAs can also be used to help minimize withdrawal rates from your RRSPs (or RRIFs, to be precise) when the market takes a dive, helping to make those savings go further. The bottom line is, both the TFSA and RRSP are important retirement planning tools; the best-prepared retirees may turn out to be those who learn to use both to their advantage.
2. A TFSA can be used as collateral
While having a good chunk of cash in your RRSP may help the bank look more favourably on you when you are seeking a loan, your RRSP cannot serve as collateral. Your TFSA, however, can be used to back a loan, providing you with better access to credit and potentially better rates.
3. Unused contribution room is carried forward
Beginning in 2009, every Canadian over the age of 18 (with a valid Social Insurance Number) became eligible to contribute $5,000 per year to a TFSA. Compared to the whopping $22,450 (up to 18 percent of your income) maximum contribution that can be made to an RRSP, this doesn't seem like a whole lot. But what you may not know is that the $5,000 contribution is for each year, and it continues to be there whether you use it or not. So, even if you haven't even thought about contributing to your TFSA yet, you automatically have $15,000 of TFSA contribution room in 2011 (from the past 3 years). That contribution room will continue to grow year upon year.
4. Contribution room is restored after withdrawals
One of the best things about a TFSA is the amount of freedom it provides. You can take out money whenever you want without penalty. That, in itself, makes it a pretty handy tool to have. In addition, whatever you withdraw can also be replaced without affecting your contribution room (one caveat: any money you withdraw must be replaced in another calendar year). This differs from an RRSP, where most types of withdrawals are permanent (and come with taxes and other penalties). So, unlike an RSSP, which you really, really shouldn't dip into before retirement age, a TFSA works well for short-term savings and for any big purchases you might have set your heart on.
5. A TFSA doesn't impact your eligibility for government benefits
Unlike your RRSP, what you have saved in your TFSA will not affect your eligibility for government benefits such as the Canada Child Tax Benefit, Old Age Security or the Guaranteed Income Supplement.
6. Any investment vehicles you can use in an RRSP you can use in your TFSA
According to the BMO survey, 37 percent of Canadians had no idea what investments were eligible for the TFSA. More than half of them weren't even sure if cash was eligible. Hello - this is a savings account! Most Canadians are much more familiar - and comfortable - with RRSPs. So remember this: any investment that can be held in an RRSP can also be used in a TFSA; this includes GICs, cash, stocks, bonds and mutual funds. Got it? Good.
7. There are no limits on when you can cash in your investment
There are many restrictions on RRSPs - not so with TFSAs. You can withdraw funds at any time without penalty. This makes them a good savings vehicle for those over the age of 71 who are no longer eligible to contribute to their RRSPs, and must begin withdrawing from them. TFSAs are one investment where you can shoot for great returns and keep all the spoils, or spend them whenever and on whatever you want. Those are strengths that are hard to beat by any other (legal) type of investment account available today.
Too good to pass up
Don't let confusion about TFSAs keep you from contributing. When it comes to reducing taxes, this level of government amnesty is rare, making this new investment tool one that is too good to pass up.