Tuesday, 20 September 2011

The New TFSA vs. RRSP vs. Doing Nothing


So what is the noise about this new Tax Free Savings Account? How does it compare to an RRSP? An RRSP will work best when you plan for your tax rate at withdrawal to be less than your current tax rate. The TFSA seems to work opposite to an RRSP. If your current tax rate is lower than your retirement tax rate then the TFSA is were you want to start.
Lets go over some basics for those who may not understand the difference between these two methods of saving:
  1. Money placed in your RRSP is not seen as taxable income by the government. Your pre-tax dollars then grow tax free until you withdraw them. What you withdraw and only what you withdraw is then treated as taxable income.
  2. Money saved in your TFSA is taxed in the year you earn it. The big benefit is that the money in your TFSA grows free of tax. When you decide to withdraw the money, the principle and the interest are free from being taxed so you don't pay the government a penny!

Take a look below to see how they compare*:


Who can benefit from this new account?
  • Anyone who has used all their RRSP contribution room.
  • Young people people over the age of 18 who have time on their side to let their money compound.
  • People with a small amount of taxable income and don't benefit from the tax deductions of RRSP's. (Some business owners, low income people, etc)
  • Seniors who can no longer contribute to their RRSP's

So what are the details that matter to you when you try to use this account? 
  • Anyone 18 and older can use it
  • You can contribute up to a maximum of $5,000 per year (future amounts are planned to grow with inflation and be rounded to the nearest $500). 
  • Carry your unused contribution room forward indefinitely.
  • Amounts withdrawn from your TFSA are added back to your contribution room unlike RRSP's.
  • Contributions that exceed your limits will be charged a penalty tax of 1% per month.
  • You can invest your money in pretty much the same investments permitted by RRSP's although the firm you invest in must be arms length from you (generally to exclude personal shares in a family business, etc).
  • Contributions are NOT tax deductible however income earned and withdrawals are both tax-free.
  • Amounts withdrawn from this account and all income earned will not affect other tax credits or benefits that use an income test for qualification (such as the Child Tax Benefit, GST Credit, the age credit, OAS benefits, Guaranteed Income Supplement, Employment Insurance benefits, etc.)
  • Money borrowed to invest in the TFSA will not generate tax deductible interest.
  • TFSA can be used as collateral for a loan, unlike your RRSP.
  • Tax-free status ends at the death of the account holder unless the spouse/common-law partner is the beneficiary. (Recieving the TFSA from a spouse does not affect their individual contribution room)
This is an account that almost every Canadian can take advantage of. For more details on how this can fit into your situation, contact us.

*Assumptions made for RRSP, TFSA and Non-registered savings as follows: $3,500 is saved in all cases; $1,500 tax deduction is included in the savings and growth of the RRSP; 30% tax rate at time of savings and at time of withdrawal; Investment growth of 10%; Non-registered growth taxed annually at 30%.

Data obtained here has been obtained from the 2010 Canadian Federal Budget and is subject to change without notice. Tax advice should be obtained from a qualified tax advisor.

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