The truth about TFSAs

The truth about TFSA limits, tax rates, etc.

January 9, 2016

Happy New Year!You may have noticed we have a new governing party in Ottawa and you may have also heard a lot of noise about TFSA limits, income tax rates and other changes. You may, like a lot of other people, be confused.

Well, I’m here to set the record straight.

Tax Free Savings Accounts, commonly called TFSAs, have proven very popular. There is no tax deduction for contributing, unlike making an RRSP contribution. However, all investment income earned within the plan is tax-free, and there is no tax or other negative effect when money is withdrawn, again in contrast to the RRSP.

In 2015, the previous government raised the TFSA annual contribution limit to $10,000. This meant that at the end of 2015, anyone who had been 18 or older in 2009, when the TFSA plans began, had a cumulative limit of $41,000.

For 2016 and subsequent years, the new government has reduced the annual limit back to the previous $5,500. However, a taxpayer’s cumulative limit is now $46,500. So, nothing lost, except future growth.

Any amount not used in the current year carries forward, and is added to the limit for the next year, and so on.

Tax-free withdrawals are allowed at any time. As well, the amount of any withdrawal is added back to your contribution limit the following January 1. For example, if you withdrew all $41,000 in 2015, you can deposit it again in 2016, plus the new $5,500.

TFSAs can be opened at a bank or credit union, investment dealer, discount broker, mutual fund company or life insurance company. You can have more than one account, but the overall limit still applies.

Remember that the TFSA account is separate from the investment options that are selected to go inside the account. Think of the TFSA as a garage, which shelters investment income from tax, and the vehicles inside it are the investments. For example, once a TFSA is opened, the money contributed can be put into a daily interest savings account, GIC, term deposit, mutual funds, ETFs or individual stocks and bonds.

The more you earn, the more value you get from the tax-sheltering. Earning 1% a year does not save you much tax, but earning 10% a year saves you a lot.

So how do you make this work for you? Let’s say that your $46,500 was invested today in, for example, mature company shares paying 3% dividends and growing at 3% per year, for a total return of 6%. It would grow to almost $150,000 in 20 years, assuming all dividends are re-invested. The $103,000 of investment growth would not be taxed, and the entire amount could be withdrawn without even appearing on your tax return. Yay!

If you add $5,500 at the beginning of each year going forward with the same assumptions, the account could grow to over $350,000.

Based on this, I think that maximizing the benefits of the TFSA as an accumulation vehicle to grow capital for future retirement income is its best possible use.

RRSP

The RRSP limit each year is 18% of your earned income for the previous year, subject to a maximum dollar amount. That max was $24,930 in 2015 and will be $25,370 in 2016. “Good news” is that if your taxable income is above $200,000 in 2016 and beyond, you will get a bigger tax benefit for your contribution than before the election.

The bad news is that this is because your tax rate has increased, as the new government promised. On the other hand, middle income earners will get slightly less benefit for their RRSP contribution, because tax rates on the federal middle bracket (between $45,282 and $90,563 taxable income) are going down by 1.5%

See – it’s all in the way you look at things.

Another example - this will be the coldest weekend of the year, but at least it hasn’t happened until January 8. Stay warm!

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Dollars and Sense is meant as an introduction to this topic and should not in any way be construed as a replacement for personalized professional advice.Please consult legal, tax and investment experts for advice on your unique situation.

David Christianson, BA, CFP, R.F.P., TEP, is a financial planner and advisor with Christianson Wealth Advisors, a Vice President with National Bank Financial Wealth Management, and author of the book Managing the Bull, A No-Nonsense Guide to Personal Finance.