It need not be an either/or approach.
Wise investors embrace the Tax-free Savings Account (TFSA) in pursuit of long term goals, like retirement.
I summarize my 2017 TFSA primer:
1.) How TFSAs work
• Canadian residents, age 18 or older, who have a Social Insurance Number can open a TFSA.
• One TFSA account per individual should suffice most cases. Be aware of plan fees if you own more than one.
• There is no deadline for making TFSA contributions as the unused contribution room is carried forward.
• A withdrawal in any calendar year increases the TFSA room in the following year.
• TFSA contributions can be made in cash or “in kind” based on the calendar year.
• Deemed disposition rules for “in kind” contributions are the same as those for RRSPs.
Your maximum TFSA deposits are as follows:
* Same amount annually thereafter
• The maximum 2017 deposit is $52,000 for those who have not yet contributed to any TFSA. This sum is expected to rise by $5,500 annually.
• All unused TFSA contribution room can be carried forward indefinitely to future years. Over contributions will attract a 1%/mo penalty.
• You can withdraw funds from the TFSA at any time on a tax-free basis for any purpose. However, understand the plan withdrawal fees that may apply.
• Withdrawn amounts can be re-deposited into the TFSA in a future year without impacting contribution room. Qualifying investments are the same as the RRSP.
• Neither income earned in a TFSA nor withdrawals will affect eligibility for federal income-tested benefits and credits. Such as age credit and the OAS clawback.
2.) How TFSAs differ from RRSPs
• An RRSP is primarily a savings vehicle for retirement. The TFSA can be used for practically everything. Both plans offer advantages, but they have key differences.
• Contributions to an RRSP are deductible and reduce your income for tax purposes. In contrast, your TFSA contributions are not deductible.
• Withdrawals from an RRSP are added to your income and taxed at current rates. Your TFSA withdrawals and growth within your account are tax-free.
3.) What happens on death or marriage breakdown
• TFSA assets can be transferred to a surviving spouse’s TFSA without affecting the spouse’s contribution room.
• Alternatively, an individual can name a spouse as the successor TFSA account and maintain tax-exempt status.
• In case of a marriage or relationship breakdown, TFSAs can be transferred tax-free between spouses or common-law partners without affecting the recipient’s TFSA room.
4.) Benefits of saving in a TFSA
• TFSA contributors will enjoy additional benefits as compared to saving in an RRSP or cash account. Capital gains and other investment income earned in a TFSA is not taxed.
• Draws from a TFSA can be used for any reason. All withdrawals can be re-deposited into the TFSA in future years. In contrast, only LLP and HBP draws can be re-deposited into the RRSP.
• TFSA deposits have no age limit. RRSP deposits end at age 71, unless there is a younger spouse.
5.) My rules for TFSA/RRSP deposits
• TFSA deposits make desirable saving tools, say an emergency fund, particularly in years of lower incomes. The RRSP contributions make more sense during years of higher income.
• Retirees with RRIF withdrawal regimes can help fund the annual TFSA deposits if they don’t require part or all of the RRIF draws.
6.) Sample TFSA accumulation
• TFSA deposit of $52,000 was made on January 01, 2017.
• TFSA deposit of $5,500/Yr is made for 25 years, starting January 01, 2018.
* Figures rounded
TFSAs and RRSPs are both very useful saving vehicles, for different reasons.
Understanding the differences helps make better TFSA and RRSP/RRIF decisions.
Adrian Mastracci, MBA, is portfolio manager for Vancouver-based Lycos Asset Management, specializing in designing and stewarding retirement portfolios.