Tax Free Savings
A Tax-free Savings Account (TFSA) is a missed opportunity for many Canadians who have either not set up a TFSA or are using it to hold low interest GICs. The attraction of a TFSA is tax-free investment growth (interest, dividends and capital gains) without any income reporting for tax purposes when you withdraw funds from your TFSA.
Contribution Room Grows Each Year
Introduced in 2009, Canada Revenue Agency (CRA) currently allows all Canadian residents 18 and older to contribute up to $5,000 per year on a cumulative basis. This means your allowable contribution room grows each year, if not used. (This annual cap is indexed to inflation and will adjust over time in $500 increments). CRA tells you how much room you have to contribute to your TFSA when they confirm your annual income tax payment (Notice of Assessment) or when you make enquires to “My Account” on the CRA website. It is important to make sure you don’t over contribute because there is a 1% penalty per month for over contributions.
Tax Free Withdrawal
Like a RESP or RRSP you can invest in a wide range of investment options. Many Canadians are using their TFSA to achieve short term savings goals and are holding low interest GIC type investments. A TFSA is most interesting as a long term savings vehicle with a goal of getting maximum long term growth. This is because while unlike an RRSP, you do not get a deduction for your contribution; you also do not have to recognize any income when you withdraw funds from your TFSA. All money withdrawn from your RRSP is considered taxable income.
Benefit From Compound Growth
The power of compounding works magic in a TFSA, the higher your rate of growth and the longer the time held, the greater the benefit to you. At 6% compound growth, the value of your original investment doubles every 12 years rather than every 36 years, if you only get 2% from a GIC. If the 6% investment is left to compound for 25 years your original investment would represents less than ¼ of the value sitting in your TFSA. That makes the tax free withdrawal look very interesting.
Flexible Savings Vehicle
When you take money out of your TFSA, unlike your RRSP, you can put the money back in to continue your tax free growth. However, you have to wait until January 1st of the following year to put the money in if you do not have any available contribution room.
Preferred Savings Option
For younger and older Canadians, the TFSA may be the preferred savings alternative to an RRSP. If you are young and your income is relatively low, the future tax-free withdrawal from your tax-sheltered TFSA will likely be much more valuable than the small tax deduction available from an RRSP contribution. For older Canadians, the ability to access funds without recognizing income and triggering claw-backs on government benefits such as Old Age Security can be very attractive.
If you are not taking full advantage of your TFSA you are missing a real opportunity to reduce your current and future income tax bill while building wealth and future planning flexibility.
To open a Tax-Free Savings Account, please contact us at Pelorus Wealth Management