Although the TFSA contribution limit was reduced by nearly half this year, it doesn’t mean you shouldn’t consider having this type of savings vehicle.
Here are five reasons you should have a TFSA:
1. You want to minimize taxes on your investments
If you have a GIC in a non-registered account or a non-registered high-interest savings account, you’ll have to pay tax on any interest income you earn. If you invest $5,000 and make $100 in interest annually, it won’t be much of a tax hit.
However, the real benefit comes when you buy stocks in a TFSA. Let’s assume you bought 100 shares of XYZ Corp. at $50 each for a total cost of $5,000. Five years later, the stock has doubled and you decide to sell your 100 shares at $100 each for a total of $10,000 and a capital gain of $5,000 ($10,000 – $5,000 = $5,000). Capital gains are taxed at half of your marginal tax rate. So if you live in Ontario and your marginal tax rate is 31.48%, the capital gains tax rate is 15.74%.
While you could also avoid buy stocks in an RRSP and not pay capital gains taxes, you’ll eventually have to pay tax when you take money out of your account because withdrawals count as taxable income. A withdrawal from a TFSA isn’t considered taxable income.
2. You’re out of RRSP contribution room
If you’ve managed to max out your RRSP (this is the kind of problem most of us would like to have) and want to continue to minimize the amount of tax you have to pay, a TFSA is your best bet.
Also, you’re no longer allowed to contribute to an RRSP if you’re older than 71. By Dec. 31 of the year you turn 71, you must either withdraw all of your money from an RRSP, convert it into a registered retirement income fund (RRIF), or use the funds in your RRSP to purchase an annuity. Contributing to a TFSA will allow you to shelter your taxes.
3. You want flexibility
A TFSA isn’t your typical savings account—you’re allowed to invest in mutual funds, stocks, bonds, and GICs. You can use a TFSA to build an emergency fund, save for retirement, save for a home, or all three.
When it comes to making withdrawals, you can withdraw as much as you want and you don’t have to re-contribute what you’ve withdrawn. If you’ve maxed out your TFSA and want to re-contribute what you’ve taken out, you’ll have to wait until the following year.
4. You get more contribution room every year
With an RRSP, you need to have earned income in order to get contribution room. And the more money you earn, the more contribution room you get up to a certain maximum each year ($25,730 in 2016).
With a TFSA, you get additional contribution room even if you don’t have an income. You also get the same amount of additional contribution room each year as every other Canadian over the age of 18. You can determine your personal TFSA limit with our handy calculator.
5. You expect to be in a higher tax bracket in retirement
In retirement, most Canadians expect to be in a lower tax bracket. But some low-income Canadians will have a higher income in retirement when they start receiving Canada Pension Plan and Old Age Security (OAS) benefits as well as the Guaranteed Income Supplement (GIS). Withdrawals from a TFSA won’t reduce your income-tested benefits like OAS and GIS.
- 4 Accounts You Can Use to Reduce Your Taxes
- The Differences Between RRSPs and TFSAs
- What is a TFSA? 5 Common TFSA Questions Answered
Flickr: Alex Vakulenko