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Tax Free Savings Account, or TFSA for short, is the best investment account available in Canada. There, it’s just that simple 
and I’ll tell you why if you read on. It was recently created compared to its competitor, or should I say, sidekick The sidekick in question is the Registered Retirement Savings Plan (or RRSP). It has been around for quite a while and many are struggling deciding between which account to use from time to time. Lots of efforts goes on at the government level to have its citizens save for retirement and the rainy days.
When it was first announced, I jumped on the opportunity to invest my savings in a TFSA account. I can grow my savings Tax Free and I can withdraw it when I want. If I want to, I can even transfer it to its sidekick – the RRSP and I can leverage the tax refund if I so desire. When I think about my TFSA account, I don’t have to extrapolate 25 years down the road and think about what my tax situation might be, how it will impact my OAS and other benefits but the RRSP account has me looking deep into the crystal ball…
TFSA vs RRSP
The 2 accounts are really sidekicks and meant to be used together but for many, it’s a tug of war to pick one. When there is only enough fund for one and you must choose, I say pick the TFSA account especially early in your career when your income is relatively low.
Why is the TFSA the best investment account you may ask? Let me outline the benefits:
- [Thumbs Up] Tax Free Growth
- [Thumbs Down] $5,500 annual contribution limit (as of this year, previously $5,000)
- [Thumbs Up] No Withdrawal Penalties
- [Thumbs Up] Withdrawals Are Not Considered Income (http://www.tfsa.gc.ca/tfsapamphlet-eng.html) – this is huge in retirement – let’s hope the government doesn’t adjust it
- [Thumbs Up] Withdrawals amount are added back to your contribution room for the following year
The only draw back on the TFSA is the small contribution we are allowed to do. However, the TFSA account can only be defined best investment account by comparing it so let see what the RRSP account has:
- [Thumbs Up] Tax Free Growth
- [Thumbs Up] 18% of gross contribution limit (cap at $23,820) – a much larger cap
- [Thumbs Down] Withdrawals Are Taxed as Income
- [Thumbs Down] Withdrawals amount do not adjust future contribution room – once it’s used it’s gone.
The Thumbs Down on the RRSP withdrawal is based on the fact that your income defines the tax situation and since everyone’s situation is different, it’s really difficult to assess the future income tax of a family. All is hypothetical but being taxed is definitely worst than not being taxed. One question to even ask yourself is if the tax on RRSP withdrawal is worst than the dividend income tax in a non-registered account …
TFSA Roadmap
Here is what it can look like for a young individual or family.
- Invest in your TFSA for many years. Max it out if you can.
- At the point you want to purchase a place, make a $25,000 RRSP contribution (at least 3 months prior to a withdrawal) and use the tax refund to add to your down payment. ($25K is the maximum for Home Buyer’s Plan -HBP)
- You can add to your down payment by withdrawing more from your TFSA if you want.
- Keep on adding to your TFSA and invest it wisely
- One day, you can make a withdrawal to accelerate paying down your mortgage or just to pay for a car
- If you can, save more and keep your TFSA for your retirement
For an older family with RRSP savings, here is what your TFSA roadmap can be.
- Find ways to add to your TFSA just like you would do for RRSP
- Use your TFSA as a lump sum mortgage pre-payment if that’s the most important goal
- Keep building your TFSA
- Use your TFSA wisely along with your other accounts to minimize taxes in retirement or near retirement.
Readers: What’s your TFSA Roadmap? Do you find the TFSA the best investment account?
Image courtesy of David Castillo / FreeDigitalPhotos.net
Try running a calculation where you withdraw dividend income all year and add this amount to your next years allowable contribution.If you’re withdrawing divs in the 5% range this will increase your allowable over the years. Some say it’s better to grow the TFSA with Drips but the growth rate would be fairly low right now. Maybe in 10 years these accts would be large enough for that to work.
I agree that for most people it should be simple: max out the TFSA then worry about the RRSP. The one exception is people whose children will start post-secondary education in 6 years or less. For them, I’d suggest maxing out the RESP to the max per child of $5000/y to get the max CESG of $1000 before contributing to either a TFSA or a RRSP. That’s assuming they intend to help pay for their child’s education.
@Bet Crooks
Very good comment about RESP. There definitely is another strategy at play here. That only complicates it all, doesn’t it
I have a LOC (3.5%) which I use for an investment account (interest is deductible)so all my dividends from the TFSA are used to pay down the LOC. So, while the amounts generated every three months are minimal and are not “worthwhile” investing on their own they do “pay” me 3.5% (less taxes of less deductible interest of the LOC).
As of Jan 1st they (withdrawals) get put back in to the TFSA along with the yearly allowed amount. This makes for a somewhat larger sum to re-invest and therefore overall less transaction fees.
The TFSA is bringing in over $1K per year in dividends, increasing every year.
I just wonder what the government of the day will do when some of the luckier young people might conceiveable have 10K – 15K per year generated in their TFSA’s. I am pretty sure that the finance minister of the day will be salivating thinking of how he can tax this back some how.
@Richard
I think so too but it’s fine to dream for now
Well done with your investments!
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