Maximize the flexibility of a TFSA: Think long term
Posted by Admin on August 26, 2010
The tax-free savings account (TFSA) has proven to be a popular vehicle for Canadians to reach their short-term savings. Many have used the account to invest in guaranteed investment certificates (GICs), high interest savings accounts and term deposits. Using this account type to meet short-term needs may be appropriate for you, but a TFSA is most powerful as part of your long-term financial security plan.
Most Canadians view the registered retirement savings plan (RRSP) as the primary vehicle for long-term retirement savings, but a TFSA has benefits, like tax-free growth, that complement long-term savings too. Withdrawals do not increase taxable income and don’t affect eligibility for income-tested credits like old age security, age credit, or the goods and services tax (GST) credit.
Which to do first, if you can’t do both
Investing fully in both accounts would offer the most tax savings, but not everyone is capable of doing so. Deciding to which you should contribute at any given time – RRSP or TFSA – depends on several factors, including your current and future tax rates. When combining both savings vehicles with a long-term view, it’s important to consider when you intend to withdraw money from your account. Although what you do will depend on your unique situation, consider the following:
| Compare your current situation to the future. | Which first, TFSA or RRSP? | Rationale |
|---|---|---|
| Do you expect your tax rate when you withdraw money to be the same as your tax rate today? | Either TFSA or RRSP. | Both accounts will provide similar benefits over the long term |
| Do you expect your tax rate when you withdraw money to be lower than it is today? | RRSP first, then TFSA | The immediate tax savings from the RRSP will likely be greater than the tax you’ll pay on withdrawal |
| Do you expect your tax rate to be higher than it is today? | TFSA first, then RRSP | TFSA may actually save you more taxes since you’ll have proportionately higher taxes on your RRSP withdrawals than you’ll receive in benefits when you contribute |
TFSA: Quick facts
- Available to individuals age 18 and over who have a social insurance number
- Contribute up to $5,000 per year. The contribution limit is indexed to inflation
- Carry forward unused contribution room indefinitely, like an RRSP
- Pay no tax on investment income and withdrawals
- Give money to a spouse to contribute to his or her TFSA without tax consequences
If you are planning for retirement, close to retirement, or even in retirement now, a TFSA might be right for your financial security plan. I look forward to speaking with you about how a TFSA fits for both the short and long term.
Neither Freedom 55 Financial, a division of London Life Insurance Company, or its financial security advisors can give fiscal, legal or accounting advice. You should seek independent professional advice on such matters from your lawyer or accountant.