Tax Free Savings Accounts (TFSAs) were introduced just over four years ago. And by the fall of 2012, 60 per cent of those surveyed by BMO said they considered themselves knowledgeable about this new investment vehicle.
But even those who know the basics could benefit from learning about some of the lesser-know ways that TFSAs can boost retirement savings.
A TFSA is a registered account that, subject to certain requirements, lets you earn investment returns without paying tax on them. Any Canadian of the age of majority, with a valid Social Insurance Number, can open a TFSA and contribute the annual maximum for 2013 of $5,500.
“The annual maximum contribution was $5,000, but just this year it got increased to $5,500,” said Domenic Gallippi, Head of Term Investments at BMO in Toronto. “There’s a formula that the Canada Revenue Agency has for when they increase it – it’s always in response to inflation pressures and it’s always in increments of $500. It could very well be that in a few years the maximum will be $6,000.”
And despite the fact that they’re named “savings accounts,” TFSAs can hold the same type of investments that Registered Retirement Savings Plans (RRSPs) can, including stocks, bonds, mutual funds, Guaranteed Investment Certificates (GICs) and cash.
Carrying forward and restoring room
TFSAs were first introduced in 2009, so each year that a Canadian is over the age of majority after 2009, they generate contribution room. That means, if you were over the age of majority in 2009 and you haven’t contributed anything to a TFSA since they were introduced, you may have up to four years of past contribution room that you can carry forward. That’s $5,000 per year for the first four years plus $5,500 for 2013. That adds up to $25,500 that you can use to start generating tax-free returns for you.
Additionally, if you withdraw funds from your TFSA, that amount can be redeposited the following calendar year. For example, if you contribute $5,500 to your TFSA in January of this year, and withdraw $2,000 in June, you can add that $2,000 to your contribution room for the following year.
According to Gallippi, TFSAs are “an ideal vehicle for income splitting” because contributions are not limited by earned income.
“If my spouse has $25,000 available in TFSA contribution room, she is in a lower tax bracket than me and I’ve maxed out my TFSA,” says Gallippi, “I can give her $25,000 to invest in her TFSA, because attribution rules don’t apply, and as a couple, we’re not paying tax on it.”
A TFSA, unlike an RRSP, can serve as loan collateral, giving you better access to credit and, often, a better rate on a loan.
Because TFSA balances are still relatively low, Gallippi says it hasn’t been very common yet for lenders to see TFSAs used in this way, but it might become more popular in the future.
Benefits for government benefits
TFSAs can also help increase retirement cash flow because they don’t affect a person’s eligibility for income-sensitive government benefits, such as Old Age Security or the Guaranteed Income Supplement. Withdrawing funds from a registered account, on the other hand, can subject an investor to clawbacks.
Helping the next generation
This last little-known fact about TFSAs won’t necessarily help the investor with his or her own retirement, but it could positively impact the next generation of savers.
When a TFSA owner passes away, if a spouse or common-law partner has been named as beneficiary or successor account holder, the assets won’t be counted as part of the estate.
“The assets in the plan can actually bypass your estate and may be passed along to the spouse or common-law partner and maintain their tax-free status,” Gallippi says. “You’re essentially avoiding probate fees this way and not impacting the survivor’s TFSA contribution room.”
There’s always more to learn about retirement planning. If you’re looking for more information about TFSAs or more ways to maximize your retirement income, a professional financial advisor can be a great help.