Beat the taxman with a Tax-Free Savings Account!
Yes, you can beat the taxman! In fact, you have the legal right to arrange your financial affairs within the law to pay the least amount of taxes possible. Make sure you exercise that right. This is legitimate tax planning, and nothing to feel guilty about (unlike breaking that New Year’s resolution to diet and exercise). The result of proper tax planning is more money in your pocket and less to the Canada Revenue Agency (CRA). In fact, the government goes so far as to make it easy to slash your tax bill, if only you’d take the trouble to do it. One of the best ways is something called the Tax-Free Savings Account (TFSA).
What is a TFSA? The TFSA is your best bet for creating immediate tax-free investment income. A TFSA is a special federal government-registered account, introduced in 2009, that lets any investments held within it accumulate tax-free. In addition, withdrawals from the account are also completely tax-free.
As you’d expect, there are a number of rules, some of which can be quite complicated. It’s a government program, after all, so we’d all fall over in a dead faint if there weren’t some complications and confusions.
How much can you contribute? Basically, you can contribute up to a maximum $5,000 to a TFSA for every year since it began in 2009, up to 2012. Starting in 2013, the government raised the annual limit to $5,500. In 2015, the Conservative government raised the limit to $10,000. However, that was repealed the next year by the incoming Liberal government, and the limit was reduced back to an annual $5,500. What many people do not realize, though, is that the one-time $10,000 limit in 2015 still counts towards contribution room if you didn’t contribute in that year. So if you haven’t ever made any contributions to a TFSA, as of 2017, you have $52,000 in contribution room available. That’s $52,000 that you can invest right away, with absolutely no tax payable on any income or growth from that investment – ever!
The contribution limit is not income-tested, the way it is for an RRSP, so anyone can contribute the allowable annual maximum every year regardless of their income level. Unused “contribution room” can be carried forward and used in future years.
Are contributions tax deductible? Something to remember, though, is that contributions are not tax deductible the way they are for RRSPs. In other words, you are investing after-tax income, but then again, there’s no tax payable at the back end.
One downside may be that like an RRSP and other registered plans, the tax benefits of certain kinds of investment income are lost within a TFSA. For example, the dividend tax credit is not available. And you do not have the ability to use tax losses to offset capital gains. You also lose the capital gains exemption inside a TFSA, but this is a moot point really, because any capital gains generated by investments in the account are completely tax-free anyway.
When can you withdraw funds from a TFSA? Withdrawals can be made at any time, but you have to be careful you don’t contribute, withdraw, and recontribute in the same year. This is one of the “complications” I mentioned earlier. If you do start using your TFSA like a straight deposit savings account, you may fall afoul of the penalties for overcontributing in a given year, and these can be pretty stiff. So make sure you check with your advisor if you plan to make withdrawals from your TFSA. As a rule of thumb, treat your TFSA as a tax-sheltered investment vehicle, much like an RRSP, and not as a place to park cash for day-to-day expenditures.
A TFSA is a very powerful investment growth vehicle. And it’s entirely possible to retire with a million dollars completely tax-free with a TFSA if you start now.
© 2017 by Robyn K. Thompson. All rights reserved. Reproduction without permission is prohibited. This article is for information only and is not intended as personal investment or financial advice. Securities mentioned are not guaranteed and carry risk of loss.