Happy 10th Birthday, TFSA!

 It seems like yesterday.  But it’s not! 

It has been ten years since the “new kid on the block” was introduced to Canadians.  This coming January we sing, “Happy Birthday!” to the Tax Free Savings Account (TFSA). 

When the TFSA was first introduced in 2009, I was working as an Investment Specialist.  I remember those initial conversations with clients. The contribution limit of $5,000 for some seemed so insignificant; they could not see the benefits of investing their money in a TFSA to shelter the modest investment income they would earned in that first year. However, for a couple, sheltering the income on $10,000 proved to be a great starting point.

Now look at the total contribution limit! 

Canada Revenue Agency (CRA) recently announced the contribution for 2019 would be raised to $6,000, a modest increase from the previous three years’ limit of $5,500.  If an investor has been faithfully socking away money into this favorable investment account, as of January 1^st the total limit will be $63,500.  What first may have appeared as an insignificant amount ten years ago has certainly become attractive for any individual or couple looking to protect investment income from being taxed. 

The majority of seniors who held money in non-registered investments embraced the new investment account.  Every year they would transition money subjected to taxation into the haven of the TFSA where taxation was prohibited. Rightly so!  They lowered their total income.  In turn, they could take advantage of the potential tax credits and government benefits.  

  

What You Need To Know

1.  Which is better?

The confusion begins with people who are currently employed and cannot decide whether TFSAs or RRSPs are a better fit for their needs.  Like any investment products, both have their pros and cons.

When money is invested into Registered Retirement Savings Accounts (RRSP), the contribution reduces the annual taxable income (advantage).  When the money is withdrawn from this safe-haven, the withdrawal amount, like employment income, adds to the annual taxable income (disadvantage).  The opposite is true with a TFSA.  A contribution to a TFSA does not reduce taxable income and likewise a withdrawal from a TFSA does not increase taxable income.

2.  Where’s the answer?   

Deciding which investment account is better suited to your needs, the answer is determined by asking, “What are your goals?”  The diagram below is quite clear about identifying three things: your goals, time horizon, and risk tolerance.  Playing the guessing game to determine which investment product will work is pointless.  Once you clearly recognize what you want to achieve, then you can evaluate your time horizon and risk tolerance.  

3.  What’s in a name?

Many articles place blame on the name, Tax Free Savings Account.  Most people associate the word, “savings”, with an investment made in a low-interest earning account.  What you need to know is the sky’s the limit when you are deciding where to invest your money. Your choices are everything from a daily savings account to GICs, stocks, bonds, mutual funds, and exchange-traded funds.

4.  Where’s the secret?     

If you are one of many people who are caught at the impasse of saving for retirement and cannot decide which investment account is more advantageous, the secret is in your taxable income.  Your marginal tax rate (MTR) is your deciding factor.  The MTR is the rate of tax you will pay on your next dollar of income, both federal and provincial.  As your income climbs higher from one tax bracket to the next so will your marginal tax rate. 

For example, if your annual income is $50,000, then your marginal tax rate (MTR) is 33% (20.5% Federal + 12.5% Saskatchewan).     

5. What’s the difference? 

Once you know your MTR, then you are ready for the next question. 

“Will your retirement income be higher or lower than it is currently when you make the contribution?” 

Once you know this, you have your choice.

6.  What’s another tactic?

To simplify the process, the chart below asks you to pick an answer (higher or lower) to determine an appropriate strategy. 

If your MTR for RRSP contribution is (higher or lower) and the MTR for RRSP withdrawal is (higher or lower), the following is more advantageous.   

7.   When’s the right time?

I understand timing is everything.  Many Canadians are self-employed and their savings are invested back into their businesses for good reasons.  These Canadians have not capitalized on the Tax Free Savings Accounts yet because the opportunity has not been presented.   Whenever the sale of their businesses or real estate does occur, they will seize the chance to tuck money into the TFSA.  The benefit of the TFSA is the ability to carry forward the contribution room into the future.  If you are one who has not opened a TFSA account, you should know that you can when the time is right for you.  The interesting fact is you can give money to your spouse and children to invest in their TFSA without any questions. 

8.  What’s the hidden trick?

A point of interest that deserves your attention is your TFSA contribution room may actually increase without your knowledge.  When you earn money on your investments (interest, dividends, or capital gains) and then opt to withdraw funds from your TFSA, the following year you can replace the full amount of your withdrawal plus the current year’s new TFSA limit.  In all likelihood, your deposit may exceed the total contribution room offered to a first-time TFSA investor.

Here’s why.  The new annual calculation includes: your TFSA dollar limit, any unused TFSA contribution room from previous years, and any withdrawals made from the TFSA in the previous year.  It’s your earnings that essentially increased your contribution room.

In a nutshell, your annual contribution room can become uncertain if you are making regular deposits and withdrawals.  As a cautionary measure, always keep a record of your transactions to take advantage of topping up your TFSA and to avoid any penalties for over-contributions.

9.  What’s the benefit?      

The Tax-Free Savings Account has served Canadians well over the past ten years. I believe they have their place in everyone’s financial plan.   This investment account can serve multiple purposes depending on individual or household needs.  Whether you are saving for something specific, like a vehicle, or funding discretionary items, like the occasional winter getaway, money can be tucked away inside a TFSA so it’s out of sight and out of mind. 

Happy 10^th Birthday, TFSA!

You’re making dreams and wishes come true!

But I believe we have to do our part.  

The encouragement is “Never under-estimate your effort, no matter how little.  Every effort, little or great is a step closer towards the actualization of your dreams.” (Chinonye. J. Chidolue)

If the effort simply means we open a TFSA account, commit to regular deposits and save money on taxes, then we are closer to our dreams.  Are we willing to give this task a little effort? Your answer needs to be a resounding, “Yes!”  

A Season and A Reason for Your Investments

At one time or another, you may have heard the familiar Ecclesiastes verses, “There is a time for everything and a season for every activity under heaven: a time to be born and a time to die, a time to plant and a time to uproot.”   I bet you never thought this could apply to your investments. 

Throughout life’s journey, your reasons for saving will vary.  You save for a vehicle, children’s education, retirement, home renovations, and vacations.  No doubt your list is endless.   The important strategy is choosing the appropriate investment vehicle and type of investments.  This is where the confusion begins.  Investment vehicles are different from types of investments. Investment vehicles, Registered Retirement Plans, Tax Free Savings Accounts (TFSA), and Non-Registered Accounts, have specific features and benefits.  Once you understand their uniqueness, you can determine a suitable fit for you.  

One way to explain investment vehicles is to associate them with the automotive industry.  We understand the differences between a truck, car, and van.  Each one services our needs differently. You may require a truck for work, a car for family purposes, and a van for travelling with young hockey players and their equipment.  You may prefer one versus another specifically because of fuel mileage, comfort,  or  safety.  Whatever your reason, you match your choice to your need.  Therefore, if you can relate investment vehicles to the vehicles you drive, you will be one step closer to differentiating Registered Retirements Plans, Tax Free Savings Accounts, and Non-Registered Savings.

Another element which adds to the confusion is the types of investments held under the respective investment vehicles. The diagram above shows that the types of investments are the same.  Whether you strictly hold GICs (Guaranteed Investment Certificates), specific bonds, stocks, or mutual funds will depend on your time horizon and risk tolerance.  {Does this sound familiar? I covered this topic in my previous blog, Can Investing Actually Be Easy.}  Again, consider types of investments linked to automotive industry as a “make” of vehicle: Ford, General Motors Canada (GMC), Toyota and Honda.  You can purchase either a truck, car, or van in your preferred "make".  GICs, bonds, stocks and mutual funds, are all different investments, yet you can purchase them as a Registered Plans, TFSA, and Non-Registered Accounts.  Once you grasp this analogy, your choice of appropriate investments will be made easy.

In order to choose the right investment vehicle, you need answers to these questions:

What is your purpose for saving?  This crucial question is important for your plan to succeed. Money set aside for retirement is invested differently than money set aside for emergencies.

What is your annual income today and what will be your annual income in retirement?  This important information determines whether utilizing a Registered Retirement Savings Plan is preferred over the Tax Free Savings Account. 

Understanding the investment vehicles’ distinct features helps you identify the benefit you can derive from its use.  Just as your vehicle has special “must-have” features like cruise control, 8-way power adjustment driver’s seat, and push button start, your investment choice also has special “must-have” features. The chart below explains some of the features to help you determine whether you can benefit from each specific investment vehicle.

Registered Investments	Tax Free Savings Account	Non-Registered Savings
Contribution room calculated as a percentage of earned income.  RRSP contribution limit reported on Notice of Assessment.	Contribution room became available in 2009 with an annual limit of $5,000.  In 2013, the annual limit increased by $500 to $5,500 indexed by the inflation rate.	Contribution limits do not apply. The sky’s the limit.
Contributions when applied reduce taxable income.	Contributions do not reduce taxable income.
Eligible to contribute the maximum amount with the option to apply the deduction to your taxable income in any given year.	Once the maximum contribution is made, the amount is reported to ensure contributions remain within the limits.
Contribution room varies according to earned income.	Contribution room is set the same for all Canadians. The exception may occur as a result of income earned on the principal.  When TFSA proceeds are withdrawn in its entirety, the new contribution limit is then equal to the principal and earnings.
If contributions are not made in current year, then the contribution room is carried forward to future years.	If contributions are not made in current year, then the contribution room is carried forward to future years.
When a withdrawal is processed, contribution room is lost and cannot be restored.	When a withdrawal is made in the current year, contribution room is restored in the following year for the same amount.
Contributions end at the end of the year of 71st birthday.	Contributions permitted from age 18 to any age.	Contributions can be made at any age.
Earnings are tax-sheltered.	Earnings are tax-sheltered.	Earnings are not tax-sheltered.
Withdrawals will be included in your income and taxed accordingly.	Withdrawals will not be included in your income and are taxed.	Withdrawals will not be taxed.  Earnings are taxed annually.
Income will affect federal income-tested benefits and credits such as Guaranteed Income Supplement (GIS) and Child Tax Benefit.	Income will not affect federal income-tested benefits and credits such as Guaranteed Income Supplement (GIS) and Child Tax Benefit.	Income will affect federal income-tested benefits and credits such as Guaranteed Income Supplement (GIS) and Child Tax Benefit.
Purpose for savings: retirement, financing your first home under the Home Buyers Plan, training or post-secondary education under the Life Long Learning Plan, or as a tool for tax deferral.	Purpose for saving: vacations, vehicle, furniture, emergency, renovations, and even a home.  May be used for children’s education if your RESP (Registered Education Savings) have been maximized.	Purpose for saving: vacations, vehicle, furniture, emergency, renovations, and even a home.  May be used for children’s education if your RESP (Registered Education Savings) have been maximized.

Understanding your investment vehicle helps you fulfill your purpose for investing and gain the greatest advantage from your investment selection. The most satisfying reward is to discover an easy way to achieve your goal by implementing smart investment strategies.  Just as all vehicles come with many options, so, too, do investment vehicles.  Using appropriate investment vehicles will allow you to drive your future dreams.