The Tax Free Saving Account (TFSA) is a great savings vehicle available to Canadian investors and an important part of your overall investment strategy. It allows you to save up to $5,500 a year with investment income sheltered from tax. Since your contributions are made in after-tax dollars, there is no income tax on the money when you withdraw it (unlike an RRSP) so you can pull it out at any time. This makes the TFSA a great vehicle for saving for a rainy day, a house, a car or a trip - anything where you want to pay less tax but still have access to your money.
Also, if you have investments in a taxable, non-registered account, you can move up to $5,500 per year into a TFSA and stop paying tax on the income. For the average Canadian with investable savings, the $5,500 savings sheltered from tax equates to an annual savings of about $72 a year. That doesn't sound like much but with compounding that can add up over the years.
Many clients ask us whether it is better to save in an RRSP or in a TFSA. The easy answer is to max out your contribution to both the TFSA and the RRSP, if you can.
But if that's not an option, then it's time to look at your marginal tax bracket and try to guess whether it will be higher or lower at retirement. From the chart, right, (click to enlarge) we can see that all things being equal, the TFSA &RRSP are better than leaving money in an unsheltered account. The income in the taxable account is reduced to 3.4% from 5.0% due to taxation. The middle two columns show that the TFSA and the RRSP perform equally well over the long run for the same $5,500 cost. There is really little difference - unless your marginal rate is lower after retirement, as shown in the fourth column. When you pull the money out at a lower marginal tax rate than when you put it in, the RRSP outshines the TFSA.
So if you cannot afford to do both, think about whether your marginal rate right now is higher than it will be in retirement. If so, go for the RRSP. If you think it will be higher, opt for the TFSA. If you think it will be about the same, then it really doesn't matter.
Here is another way to think about it. Take a look at what stage of your career you are at right now and how much your current income is vs. what you expect it to be in retirement. Using the chart, right, (click to enlarge) as a guide, if you are just starting out in your career and expect your retirement income will be more than your current income, put the money in a TFSA. That way you pay the income tax in your current (lower) tax bracket rather than in your future (higher) tax bracket. If, however, you are in the later part of your career and expect your income could be lower at some point in your retirement, then the RRSP makes more sense because you are deferring paying the income tax until you are in a lower bracket. Mid-career it's probably "6 of one and half-a-dozen of the other". Either split your contributions between the two accounts or alternate year-to-year.
A few other circumstances to think about - if you are working now, but are worried you may be out of a job at some point in the near future, put your contribution in your RRSP. Then, should your income drop rather suddenly, you have access to the money in the RRSP at a lower marginal tax rate (see chart, below). If you have already allocated money for your retirement savings and want to save for a short term goal (car, trip, etc.), put the money in the TFSA because there is no income tax implication to withdraw when you need to. If you want to encourage your self discipline to leave money you've put aside for retirement alone, you are probably best to put it in the RRSP since the income tax penalty of pulling it out will make you think twice about using it to buy that really cool new stereo you've been wanting.
If you are saving for your first house, both accounts have benefits. The home buyers withdrawal plan allows you to withdraw money from your RRSP to buy a home. You don't lose your original contribution room because you are required to pay it back over 15 years or suffer heavy penalties - another good feature for self-discipline. The TFSA does not require you to pay it back but you don't lose you original contribution room either - if you take out an original contribution of $1,000, your available room goes up by $1,000 so next year, you can put in $6,000.
ScotiaMcLeod's TFSAs are full "self-directed" accounts (like your RRSP and non-registered investment accounts) that can hold any number of securities, from GICs and bonds, to stocks and mutual funds. Scotiabank's TFSAs can hold GICs, Scotiafunds and the popular Money Master daily interest savings account. To open an account, download and complete an account application and a TFSA application. Download a Pre-authorized contribution form (TFSA) to set up convenient monthly contributions. Mail or Fax the completed forms to The Spiess McGlade Team.
Clients who don't need the full flexibility of a ScotiaMcLeod TFSA, are encouraged to open their TFSA online at www.scotiabank.com.
ScotiaMcLeod is a division of Scotia Capital Inc., member of CIPF.
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