On April 21st the Federal Govt announced that it was increasing the annual contribution room of a TFSA (Tax Free Savings Account) by $4,500. This means that anyone who was 18yrs in 2008, when the program began, can contribute up to $41,000. For those that turned 18 after 2008, the maximum contribution amount changes based on varying limits over the last 7 years – this will be worked out for you when you open one up.
A TFSA is a wonderful and flexible savings tool but does require some thought in terms of how best to use it in any particular situation.
A TFSA could be for short term or long term savings purposes and how you use yours depends on how much extra cash you have, how many years to your withdrawal, your sources of income in retirement and your tax rate at withdrawal.
Generally, if you expect your tax rate to be higher or about the same in retirement then maximizing contributions to a TFSA first before the RRSP is recommended. Investments in the TFSA should then be considered long term and growth oriented.
Couples that use retirement income splitting typically pay less tax in retirement even when drawing healthy incomes, so in most cases, maximizing an RSP for long term retirement income planning is still preferred. But any extra cash for short or long term savings should go into a TFSA.
However, if you are single before retirement and plan to stay that way, the TFSA needs to be considered for long term retirement income planning. When too much has been invested in an RSP or merged with a deceased spouses assets, no income splitting is possible and higher tax in retirement is possible.
If you have extra cash, no or little debt, have maxed out your RSP contributions then using a TFSA for short term financial goals or long term retirement income planning is recommended.
If you are saving for a car or any other short term financial goal (and don’t have a lot of extra cash) then using a TFSA may be ideal again – unless you are using the TFSA for your long term plan.
If you are a first time home buyer and saving for a down payment on a home and you have a lot of extra cash, then contributing to an RSP may be your best option as you get a tax deduction and can withdraw from the RSP without penalty – certain timing rules apply.
Under 30 somethings have a real opportunity to create a tax free retirement income. For most other than the professionals with high incomes, using a TFSA may be their best long term retirement planning strategy. Contributing $10,000/yr for 30 yrs at 8% grows to $950,000. Which, given expected inflation will not be enough to fund a 40 year retirement but it’s a great start! The disadvantage of a TFSA is it’s too easy to withdraw the hard earned savings.
Each individuals tax situation needs to be reviewed before a long term strategy is put in place. Call us if you need some help.