Mei has heard about Tax Free Savings accounts but is still not sure they are the best alternative for her investments. TFSAs are an incentive from the Federal Government (with follow-on support from all Provinces and Territories) to taxpayers to save for their futures.
Born out of the financial crisis of 2008, the TFSA was introduced in 2009 as a means to encourage average Canadians to get money out of savings accounts and back into the stock market while accumulating funds for whatever purpose the taxpayer desired, unlike Registered Retirement Savings Plans (RRSPs) which are directly focused on accumulating funds for retirement. Mei understands RRSPs but is wondering if the TFSA is a better alternative. The short answer is that neither is better than the other – they are different but have some similarities.
Unlike RRSPs, the TFSA maximum contribution limits are the same for every eligible taxpayer. The annual limit for 2017 is $5,500 for contributions to a TFSA while the cumulative limit could exceed $50,000. The TFSA is designed to accept pre-tax contributions – in other words, Mei cannot deduct her TFSA contribution from her income when doing her tax return, unlike her RRSP contributions, which are tax deductible. To better illustrate this, if Mei is in a 28.2% Tax Bracket ($52,500 of taxable income for 2016) she has to earn $1,393, pay tax of $393 and have $1,000 left to contribute – pre-tax dollars.
Where the two plans are similar is that the growth (investment returns) on the funds inside the plan are sheltered from tax – no T-5 slips or T-3 slips are issued for gains. For example, if Mei was earning 6.00% rate of return on her TFSA investments, she earns the full 6.00% however if she held those same investments in a non-RRSP, non-TFSA account, she would only keep 4.31% after taxes of 28.2% are subtracted.
Withdrawals are different for each plan. If Mei takes any money out of her RRSP, Canada Revenue Agency (CRA) will tax every dollar. However, money withdrawn from a TFSA is not taxed – not the original capital nor the growth or increase in value. Also, unlike RRSPs any withdraws from TFSA will increased the contribution room for the following year.
Let’s compare | RRSPs | TFSAs |
Deductible contributions | Yes | No |
Tax Sheltered Growth | Yes | Yes |
Taxable withdrawals | Yes | No |
For investment choices, Mei can select from any of the following for her TFSA: Guaranteed Investment Certificates (GICs), Index or Market Linked GICs, Guaranteed Investment Accounts, Segregated Funds, Mutual Funds, Stocks, Bonds or Exchange Traded Funds (ETFs).
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