The recent federal budget greatly enhanced the significance, and potential long-term value, of Tax Free Savings Accounts (TFSAs) for all adults over the age of 18. Effective immediately, each TFSA account holder’s annual eligibility becomes $10,000 — a very significant increase from the previous $5,500.
Until the recent federal budget changes, the maximum contribution eligibility totalled $36,500.
With the new rules, effective immediately, this ceiling rises to $41,000.
Going forward, every adult’s eligibility will increase by another $10,000, each January 1.
Because neither earnings nor capital gains in a TFSA are ever subject to income tax, these accounts are a superb savings and investment vehicle.
Younger Canadians and others in relatively low marginal tax brackets, can use their TFSA as an alternative to their RRSP — preserving RRSP contribution eligibility for the future, when marginal tax rates become higher, and the triggered tax refund more significant.
With the new contribution limits dramatically increasing the potential of a TFSA, the long-term benefits of TFSAs should now rival those of the RRSP program.
Younger adults can use the TFSA as a short-to-medium range vehicle to save for a down payment, a car, or other major purchase.
But as they age and as incomes grow, they can begin using their TFSA as a long-term investment vehicle.
Their investment strategy can gradually shift from a shorter-term focus, to one of long-term wealth-creation, with the objective of eventually supplementing future workplace pensions, RRSP draws, Canada Pension Plan (CPP) and Old Age Security (OAS) benefits.
RRSP or RRIF accounts trigger tax consequences with every withdrawal.
All draws from TFSAs are tax-free.
Withdrawals do not count as taxable income which may otherwise trigger a “claw-back” of part, or all, of a retiree’s OAS benefit. Nor, for lower-income retirees, will a draw from a TFSA account negate Guaranteed Income Supplement (GIS) benefits for which the pensioner may be eligible.
Furthermore, any funds withdrawn from a TFSA may be replaced in part or in full in any subsequent year — in addition to the annual increase in contribution eligibility.
With the most recent increase in eligibility limits, the TFSA can now be viewed as a major vehicle for wealth-creation and wealth-preservation for Canadians. This is particularly important given that Defined-Benefit, and even Defined-Contribution, pension plans are enjoyed by a fast-shrinking minority of employees. More than ever before, Canadians, hoping to enjoy a comfortable retirement, will need to supplement their CPP and OAS payments with their own investment portfolios.
Although a majority of adults already have a TFSA account, relatively few are taking full advantage of its potential, even when they can afford to do so. Many simply use their TFSA as a low-interest savings account, without realizing its potential as a vehicle for longer-term wealth-creation. Hopefully, the most recent federal budget publicity will serve to raise awareness, at all ages, of how best to take advantage of the TFSA.
In retirement, some Canadians are fortunate to not need to draw on their TFSA. Yet, by continuing to utilize their full eligibility, the TFSA can become a major tax-free component of their eventual estate — an important consideration for some.
For those 18 or older who have not yet opened a TFSA account, it is important to realize that their annual eligibility is cumulative.
Keep that in mind, particularly when receiving a bonus, an inheritance, or other windfall. If in a high marginal tax rate, such windfall may best be deployed to an RRSP. If in a low tax bracket, the TFSA may be the best choice.
A retired corporate executive, enjoying post-retirement as an independent Financial Consultant (www.dolezalconsultants.ca), Peter Dolezal is the author of three books, including his most recent, The Smart Canadian Wealth Builder.
