Part 5 – Tax Free Savings Accounts (TFSA): Misunderstood and Under Utilized

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In the final installment of our Turning “Tax Pain” into Personal Gain series, we look at Tax Free Savings Accounts (TFSAs). 

TFSAs are still a relatively new registered account, created in 2009. While offering a unique tax shelter, its recent introduction, or perhaps the absence of tax deductions from TFSA contributions, seem to cause it to be overlooked compared to RRSPs, despite its effectiveness as a tax planning tool. TFSAs are often the source of confusion that we hope to clear up because we believe people should make better use of these accounts.  

The confusion may lie in the fact that TFSA are, in a way, the opposite of RRSPs. As mentioned earlier in our series, RRSP contributions are made in pre-tax dollars and taxed upon withdrawal. However, TFSA contributions are made with after-tax dollars and withdrawals are made completely tax free. Like RRSPs, investment income earned inside a TFSA is not taxed, so TFSA holders only need to track money flows into and out of their TFSAs. 

While TFSA contributions do not yield a tax deduction like RRSPs, withdrawals do not impact your taxable income, nor reduce your eligibility for geared-to-income benefits like OAS. Unlike RRSP withdrawals, a TFSA withdrawal is returned to the account holder on January 1st of the following year, allowing all original contributions and growth to be returned to your TFSA. 

TFSAs are appealing for those who may need access to their funds as TFSAs allow for a lot more flexibility in withdrawals, and in the right circumstances, more tax savings opportunities than may be available with RRSPs. However, TFSAs work best when the investments are left to grow as much as possible to grow the size of the TFSA to create more tax-sheltered income in retirement.

If TFSAs sound too good to be true, there is a catch: You can only contribute a certain amount each year (for 2020 it was $6,000) and the lifetime contribution limit is $75,000 as of January 1, 2021. TFSAs are a great option for those who are currently in a low tax bracket and do not need to place a large emphasis on tax deductions or deferring their taxes. Unlike RRSPs where contribution room is based on income, TFSAs are more democratic since everyone gets the same amount of contribution room, regardless of income. 

Putting It Together for You:

To summarize, TFSAs may seem the less complicated choice of the two. And while this may be true, it can be worthwhile to explore the opportunities RRSPs offer if you must choose between the two. This is especially true if you are currently in a high tax bracket and are looking for a way to defer taxes until retirement. However, in general, if you are in a lower tax bracket and are not concerned about deferring taxes, and still want to tax plan efficiently, TFSAs allow for tax sheltered income later in life when you may be in a higher tax bracket. 

Of course, both RRSPs and TFSAs have their place in financial planning and for many both will be used. It boils down to finding the proper timing on when to fund your RRSP and when to fund your TFSA. The goal of this series was not to tell you what option is better, but to help you start asking the right questions about how to invest your money and save for your future. We hope this series helps you feel better equipped to improve your tax efficiency and direct your savings dollars.

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This information has been prepared by Dave Charlebois, Investment Advisor, and Stephen Gaskin, Associate Investment Advisor for Lighthouse Wealth Management, a division of iA Private Wealth Inc. and does not necessarily reflect the opinion of iA Private Wealth. 

The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor can open accounts only in the provinces in which they are registered.

iA Private Wealth Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. iA Private Wealth is a trademark and business name under which iA Private Wealth Inc. operates.

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