Five Reasons to Open a TFSA

People often shy away from TFSAs because they are not sure how TFSAs work and do not see the benefit of opening a TFSA versus a regular savings account. First introduced in 2009, according to RevenueCanada, about 6.8 million people have opened 8.2 million TFSA accounts to the end of 2010.

However, despite its growing popularity, the TFSA remains misunderstood and underutilized by most Canadians. This includes many of the high net worth individuals that come to us, seeking further investment advice and beneficial tax savings guidance.

 

The mechanics behind the TFSA are very simple and the benefits gained from it are significant.

 

1) The Basics

 

Canadian residents with a Social Insurance Number and who are aged 18 or older can open a TFSA. The contribution limit is currently $5,500 per year. However, if you have not yet opened or contributed to a TFSA, you can contribute $25,500 in 2013, to make use of the contribution room accumulated since 2009 (4 years X $5,000 + 1 year at $5,500).

 

The TFSA is a great investment vehicle that can be used to meet your short and long-term goals. The TFSA can hold the same eligible investments as an RRSP.  These include cash, investment funds, exchange-listed stocks, bonds, GICs, and certain shares of small business corporations. All income earned in a TFSA (including income generated from interest, dividends and capital gains) is tax-free. Withdrawals from the TFSA are also tax-free. Opening a TFSA does not impact federal benefits and credits, including the Canada Child Tax Benefit and the Guaranteed Income Supplement.

 

It can be used as an income-generating account and a savings account, whether you are saving extra money for retirement, to buy a new car, to make minor home improvements, or to have an emergency fund.

 

At Hanser Financial, we customize the asset mix within our clients’ TFSA, based on their unique investment needs and continue to adjust it to be in-sync with income requirements, changes in lifestyle, and changes in risk tolerance.

 

The TFSA is especially useful once other income-sheltering plans, such as an RRSP or RESP, have been maximized.  It provides “extra” contribution room on top of the other income-sheltering plans that you have. This extra room can be used to shelter more money from taxes and bridge any income gaps between the amount of money you have saved and your future expenses.

 

It is important to note that this account should NOT be used as a chequing account because of the contribution and withdrawal rules, which will be explained in Section (3), Flexibility.

 

2) Tax Savings

 

The contributions you make to your TFSA and the investment income you earn are never taxed, no matter whether they are accrued or withdrawn.

 

Assuming a 5.5% annual rate of return and an average tax rate of 21%, $200 invested per month in a TFSA for 20 years can potentially yield $11,000 of tax savings compared to investing in a regular savings account, where all earned interest, dividends and capital gains are taxed.

 

3) Flexibility

 

The TFSA allows you to withdraw money anytime and re-contribute the withdrawn amount in the following years. It is unlike the RRSP, where you pay withholding taxes on any funds you withdraw prior to retirement and lose the contribution room for the amount you have withdrawn.

 

Even if you cannot contribute the maximum of $5,500 to the TFSA in any given year, your unused contribution room will be carried forward to future years. If you over-contribute above your contribution limit, you will be charged a 1% monthly penalty on the amount you over-contributed.

 

It has been mentioned previously that the TFSA should not be used as a chequing account. Frequent contributions and withdrawals will quickly diminish the contribution room for the year. Furthermore, because it is hard to keep track of contributions and withdrawals, the likelihood of the 1% penalty will increase due to the increased possibility of accidental over-contributions.

 

Example: Bob wants to know how much he can contribute to his TFSA in 2012.

He made the following transactions:

 

 

 

Bob can contribute up to $15,500 in Calendar Year 2012.

 

If Bob over-contributes anything above the contribution room for any of those years, he will pay a penalty of 1% per month. If he contributes $16,000 in 2012, he will pay a 1% monthly penalty on the $500 over-contribution. He will be pay 1% X $500 = $5 per month, until he withdraws the money he over-contributed in excess of the $15,500 contribution room.

 

Keeping track of contributions to and withdrawals from the TFSA is very important to avoid accidental over-contribution. At Hanser Financial, we vigorously monitor our clients’ TFSA and ensure that it is set up in accordance with their unique investment needs to yield the maximum financial benefit.

 

4) Benefits to Seniors

 

At the age of 71, seniors are required to convert their RRSP into a retirement income vehicle. Seniors can use the TFSA to meet their savings needs after they turn 71. Investing retirement money in TFSA-eligible investments can add income on top of their invested savings capital.

 

Example: Ben and Ruth are both retired and are receiving monthly income from their RRIF. Ruth has a modest pension, while Ben has saved well. They decided to invest her pension income into a bond investment fund in their TFSA to save and generate income for their annual trip to theCaribbean.

 

When used in conjunction with an RRSP, the TFSA provides additional tax-sheltered savings that can be withdrawn anytime, whether prior to or after retirement, and the contribution room for the withdrawn amount will be available at the beginning of next year.

 

Many of our clients’ plans include using the TFSA to bridge the income gap between age 65, retirement age, and age 71, when they start receiving RRIF income.

 

5) Opportunity Cost

 

Not opening a TFSA can mean missing out on thousands of dollars of tax savings. Opening a TFSA is free and does not have any hidden costs.

 

If used correctly, the TFSA becomes a powerful tax-savings and investment vehicle, which does not tax your money within the account nor upon withdrawal. We provide clients with specialized advice, customized to fit their unique needs, investment horizon, and future plans, to maximize the value of their TFSA account.

 

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