Who should invest in a TFSA?
- New investors: TFSAs stimulate greater long-term savings when you start earlier.
- Seniors: Neither withdrawals nor income earned in a TFSA will trigger clawbacks on Old Age Security benefits or the Guaranteed Income Supplement.
- High income earners: Taxpayers who are in high tax brackets and have already maxed out their RRSP can use a TFSA to shelter more of their income.
- Lower income earners: Instead of the modest tax deduction of an RRSP, taxpayers in a lower tax bracket may prefer the tax-free growth and withdrawals of a TFSA.
- Anyone saving for a large ticket item: TFSAs can be used to fund a car purchase, vacation or down payment for a house.
It is generally a good idea to maximize both an RRSP and TFSA. The invested money would benefit from tax-efficient growth, which generally leads to enhanced portfolios in the future. A TFSA growth calculator can illustrate the type of growth you may generate when you invest in a TFSA. Go online to find a TFSA calculator today.
No one solution suits everyone. Here are some ways you can determine what plan works best for you:
- Are you investing for the short-term or long-term? If you are investing for the short-term (ex. saving for a car, vacation, etc.), a TFSA is generally considered the better option. Withdrawals from a TFSA are tax-free and you may re-contribute that withdrawal in a later year. RRSPs are generally used for long-term needs or specific short-term needs where special access is provided, such as the Home Buyers’ Plan or Lifelong Learning Plan. Use a TFSA vs. RRSP calculator to see what type of growth you can expect with each plan.
- What is your current and expected tax rate? Your tax rate at the time of contribution and withdrawal matter. For example, if you are currently taxed at a 45% tax rate and intend to withdraw your RRSP or TFSA while still at a 45% rate, the after-tax amount from each plan would be the same, assuming the rates of return are identical. When your tax rate at the time of contribution exceeds your tax rate at the time of withdrawal, RRSPs produce greater after-tax amount. On the other hand, where your tax rate at the time of contribution is lower than your tax rate at the time of withdrawal, TFSAs provide the greater benefit.
- Income-sensitive benefits. You are less likely to receive benefits such as Old Age Security (OAS), Guaranteed Income Supplement (GIS), Canada Child Tax Benefit (CCTB) and the Age Credit as your taxable income grows. This reduction of benefits can be considered an added tax for those subject to them. While RRSP and RRIF withdrawals are income that can reduce federally sponsored income-sensitive benefits, TFSA withdrawals do not. If you believe your future income may hover near clawback thresholds when you withdraw your funds, it may be better to pull from a TFSA.
Can’t contribute to an RRSP?
There are many reasons why Canadians cannot contribute to an RRSP, such as an insufficient amount of earned income, contributions to an employer pension plan or reaching the age of 71, which is when RRSPs must be converted to RRIFs. TFSAs are an ideal solution for those who have maximized their RRSPs and want additional tax-saving opportunities. Regardless of your employment status, age (other than a requirement to be at least 18), or contributions to employment pension plans or RRSPs, Canadians have $5,500 of TFSA contribution room each year, subject to inflation. Use a TFSA growth calculator to calculate what growth you could expect by investing in a TFSA.
The Versatility of TFSAs
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This should not be construed as legal, tax or accounting advice. This material has been prepared for information purposes only. The tax information provided in this document is general in nature and each client should consult with their own tax advisor, accountant and lawyer before pursuing any strategy described herein as each client’s individual circumstances are unique. We have endeavored to ensure the accuracy of the information provided at the time that it was written, however, should the information in this document be incorrect or incomplete or should the law or its interpretation change after the date of this document, the advice provided may be incorrect or inappropriate. There should be no expectation that the information will be updated, supplemented or revised whether as a result of new information, changing circumstances, future events or otherwise. We are not responsible for errors contained in this document or to anyone who relies on the information contained in this document. Please consult your own legal and tax advisor.