What Is A Tax-Free Savings Account and What Does It Mean For You
by Sandra Maraj, CFP
The Federal Conservative Government proposed in their 3rd Annual budget to introduce a Tax-Free Savings Account (TFSA) which has attributes of both a Registered Retirement Savings Plan (RRSP) and a Non-RRSP account.
Unlike a RRSP you don't have to have earned income to be eligible to contribute to a TFSA so anyone who is 18 years old, a resident of Canada and has a social insurance number is eligible to have one of these accounts. The annual contribution limit will be $5,000 per year and, similar to a RRSP, you can carry forward indefinitely any unused contribution room. Funds within the account will be sheltered from taxes and allow to grow tax-free, so interest income, dividends and capital gains will be sheltered.
However, unlike a RRSP, contributions to a TFSA are not tax-deductible; therefore, withdrawals will not be subjected to any income-tax penalties. Money can be withdrawn at anytime for any purpose and any amounts withdrawn from a TFSA can be added back to your contribution room for the following year. Contributions can be made on behalf of a spouse but unlike a RRSP there will be no income attribution.
So what does this all mean for you? Does it mean that you should no longer contribute to a RRSP? Not at all. A TFSA should be used as a complement to your RRSP, since RRSPs offer a unique benefit by allowing you to save for retirement while reducing the amount of taxes you pay today.
The contribution made to your RRSP is deducted from your taxable income, which ultimately reduces your income tax liability for the year the deduction was claimed.
The table below compares the value of a Tax Free Savings Account and a Registered Retirement Savings Plan after 20 years, assuming a pre-tax rate of return of 7% and a marginal tax rate of 46.41%.
| |
TFSA |
RRSP |
| Initial Contribution |
$5,000 |
$5,000 |
| Reinvestment of Tax Refund* |
$ 0 |
$2,321 |
| Gross Contribution |
$5,000 |
$7,321 |
Value of Account
(Contribution + Investment
Income) |
$19, 348 |
$35,206** |
| Taxes on withdrawals in retirement |
$ 0 |
$10,562*** |
| Net Proceeds |
$19,348 |
$24,644 |
*Assuming your tax refund is reinvested back into your RRSP
** Assuming refunds from such reinvestments go back into RRSP
*** Assuming a 30% marginal rate at retirement
With the passage of the budget we may see the TFSA offered by financial institutions as early as 2009.
Benjamin Franklin once said, "But in this world nothing can be said to be certain, except death and taxes." Hopefully with the introduction of the TFSA, at least one of these will be less painful!"
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