A tax-free savings account (TFSA) is more than just a savings account. It can be a versatile investing account too. Find out more about TFSAs and 9 reasons to consider opening one.
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Why should you consider opening a tax-free savings account?
A tax-free savings account (TFSA) can be a versatile saving and investing account. It’s often compared to two other popular accounts — savings accounts and RRSPs. TFSAs have things in common with both of these accounts, while not being exactly like either of them. You can use a TFSA to save for many reasons, and it is more flexible than some other tax-sheltered accounts.
A TFSA can be useful for many reasons, including:
- TFSAs aren’t just savings accounts – Despite what the name sounds like, you can use TFSAs for either saving or investing, or both. In addition to cash, you can have GICs, bonds, stocks, mutual funds, ETFs and many other products in your TFSA.
- You could reduce taxes on your investments – Your savings or investments grow tax-free as long as they stay in your TFSA. That means you can use your TFSA to shelter investments that would otherwise be taxed, since you don’t pay tax on your TFSA’s earnings. For example, if your investment was outside a TFSA, you would need to declare interest earnings or foreign investment income.
- Your TFSA funds are not taxed when you withdraw them – Unlike your RRSP, funds withdrawn from your TFSA are not taxed. This can include your original contribution amount as well as interest, dividends and capital gains generated from the investments.
- You won’t lose contribution room if you don’t use it that year – If you do not contribute or contribute less than the annual dollar limit, the unused contribution room can be carried forward into future years. This makes TFSAs a flexible way to save for any goal. And, if you withdraw some of your TFSA savings, you can put back the full amount of your withdrawal later (as long as you wait until the next year) and continue to save again. Learn more about TFSAs and how contribution rules work.
- TFSA contribution room is not tied to your income level – The contribution room is the same for all Canadians and is not based on your income. Every year, you may contribute up to the TFSA dollar limit plus any TFSA withdrawals or unused contribution room from previous years.
- You’re looking to add to your retirement savings – When you retire, you can withdraw money from your TFSA without declaring it as income. This could allow you to delay taking cash from your RRSP and paying the taxes on those withdrawals.
- You can use a TFSA at the same time as an RRSP or First Home Savings Account or use all three – Everyone’s tax situation and financial goals are different. There are many reasons why you might want to save in more than one type of account at the same time. A TFSA is designed to be used for any savings goal, not only retirement. Also, TFSA contributions are made with after-tax dollars, but RRSP contributions are made with pre-tax dollars. Your saving and investing strategy should consider your financial situation, including your income tax rate today and what you think your tax rate could be in the future, when you need the funds.
- You’re already contributing the full amount to your RRSP each year – If you have a moderate to high income, saving in a Registered Retirement Savings Plan (RRSP) will help you plan for retirement while also providing you with a deduction at tax time. If you’ve maxed out your RRSP contribution room for the year, you can still use your TFSA to save tax-free. But remember TFSA contributions won’t give you a tax deduction.
- You expect your income tax rate to be higher when you take money out of the TFSA – The money you put into a TFSA has already been taxed before you put it into the account. So, if your marginal tax rate is higher when you take the money out later on, you’ll have paid less in taxes. The opposite is true for saving in an RRSP. A higher tax rate over time will increase your tax bill when you withdraw your RRSP savings.
You can only open a TFSA once you turn 18. Unlike a typical saving or chequing account, TFSAs can only be opened once you are 18 years old. If you have a child who is not yet 18 but is keen to start one, you could encourage them to start saving for their first year’s worth of contribution room. That way they’ll be ready when they can open their TFSA.
What advantages do TFSAs have for lower-income households?
Unlike an RRSP, TFSA contribution room is not based on your income level. That means every Canadian has the same amount of TFSA contribution room. And money saved in your TFSA does not affect your eligibility for government benefits programs, such as the Canada Child Benefit or the Guaranteed Income Supplement.
Also consider whether you expect your income to be higher in retirement than it is before you retire — in other words, will you be paying a higher tax rate when you retire than you are now. If so, you may want to consider using your TFSA more for retirement savings, rather than an RRSP. This is because RRSP contributions are not tax-free — they merely defer the tax you will pay on the income until you withdraw it in your retirement. If you owe more tax in your retirement years than before you retire, then the RRSP won’t be as much of an advantage.
Summary
TFSAs can be a flexible account to save or invest for the future. There are a few things to know about TFSAs, including:
- Your TFSA contribution room increases every year, regardless of your income level. You won’t lose your contribution room if you don’t use it.
- Unlike RRSPs, TFSA withdrawals are not taxed. You also don’t get a tax deduction for your TFSA contributions.
- If you are considering using your TFSA instead of your RRSP for retirement savings, consider whether your income level is likely to be higher or lower in your retirement years. If it is likely to be higher, then the TFSA may be a good place for your retirement savings.
