Bob Tillmann, Vice-President of Marketing and Business Strategy, Manulife Investments
The tax-free savings account (TFSA) is an excellent way to save for the long term or for important purchases like a house, but is not widely understood, says Bob Tillmann, Vice-President of Marketing and Business Strategy, Manulife Investments.
TFSAs were created by the federal government three years ago to promote a higher savings rate among Canadians. They currently allow for $5,000 each year for each adult to be put into an account – from a conventional TFSA bank account to a TFSA investment account containing, say, bonds or mutual funds – and whatever is earned on that account is sheltered from tax.
"Particularly for younger to middle-age Canadians, getting started in the TFSA is a great way to save for the future," says Mr. Tillmann. "It could have a significant impact on retirement savings, if they use it as a long-term savings vehicle, because it provides much more flexibility from a tax perspective than an equivalent RRSP [Registered Retirement Savings Plan] contribution."
What sort of flexibility? Money in the account can be withdrawn without any tax having to be paid, unlike an RRSP. Younger people may not be earning income where they pay tax at the highest marginal tax rate, and the tax refund on any RRSP contribution may therefore be too low to entice them to make that contribution.
"But if you put your savings into a TFSA, you know that whatever earnings you get are tax-free as long as you keep it in a TFSA," he says. "Even if you take it out of the account, the withdrawal is tax-free. So it's a great way to build up non-taxable savings for the future."
The TFSA is also an excellent way to save for important purchases, such as a first home, or for moving up into a larger home, he says. While it may sound small, at $5,000 a year, a couple can sock away $50,000 between the two of them in just five years, plus whatever tax-sheltered proceeds they earn.
"They can build up a sizable amount of savings, and use the TFSA for a down payment, or to reduce the amount of mortgage they may have to take out on a home." And in the following years, they can replenish their account by the amount they withdrew, when they are able to.
There are other benefits, too. Those who do not contribute the $5,000 one year can make up for it later. For instance, three years down the road, they can contribute $15,000 if they haven't used up their space.
Surveys have found that many Canadians do not understand the TFSA or know about it in detail. "I'm not sure the majority of Canadians are really well-versed in TFSAs at this point," says Mr. Tillmann.
Why have Canadians been slow to take it up? "Economic reality. People are having trouble saving. They have been taking on debt partly because of the record low interest rates. The fact is, on the same wage you can afford to borrow a lot more today than you could 10 years ago. Wages are not growing at significant levels, so people are reaching the point where their pay cheques are spoken for each week when they get paid. It's hard to start depositing savings into your plan if you haven't had the habit of doing it."
He suggests Canadians talk to a financial adviser for information about TFSAs, or look online for government information.
Mr. Tillmann urges Canadians to look for ways to cut their discretionary spending and start putting money into a TFSA. "It's going to create so many opportunities down the road. If you can look five or 10 years away, this program can be a great way to help you achieve your goals and still create future flexibility, particularly from a tax perspective."