Tax-Free Savings Accounts: ups and downs

What's better than the tax-savings you achieve using Registered Retirement Savings Plans?

Why, the Tax-Free Savings Accounts!

And what is it that makes them a new favourite amongst Canada's taxpayers?

Herewith the list of Tax-Free Savings Accounts' pluses – and minuses.

A bit of defining first: the Tax-Free Savings Account actually is what it says it is: that is, a tax-free savings instrument. But it has a few conditions imposed. The most important: you can only deposit $5,000 a year to it. Not a cent more. Less, yes, more, no. But, if and when you do need the cash, you can withdraw it, no questions asked, and no explanations to the Canada Revenue Agency required.

If you need more and specific details, the federal government set up a Tax-Free Savings Account site.

No need to wait

Basically, one of the advantages is that you don't need to wait until you're retired to begin using money accumulated in your Tax-Free Savings Account (TFSA for short).

So, why even consider an RRSP, a.k.a. Registered Retirement Savings Plan?

For a simple reason: the government lets you keep all of the money you're withdrawing from the TFSA, but it still gets taxed as income upon you earning it. The fact that you later deposit it into an account that doesn't cost you a cent in taxes is nice, but that's all.

On the other hand, when you contribute to an RRSP, you're cutting the amount upon which the government can impose taxes. Of course, there's a limit, too: you can't contribute more than 18 per cent of your last year's income. The government doesn't say this is the percentage, but it does tell you how much you can contribute in real money when it sends you its assessment of your tax return. But don't worry, the government does get its due, after all: whenever you withdraw money from an RRSP, it's taxed.

Economic (and actuarial) assumption

So, what's the percentage? Here it is: based on the assumption that seniors, no matter how many pensions and annuities and whatnot they are collecting, are generally poorer than they used to be, the tax on the amount they are withdrawing from an RRSP would be lower in retirement than it would have been once they've been still getting their full salaries.

That's when and where it pays most to have an TFSA: for the time BEFORE you retire.

But, you might need this account even after you've retired. If and when you live long enough to reach the age of 71, you're supposed to convert your registered retirement savings into a retirement income vehicle, whatever THAT is.

And if you earn money from a TFSA or withdraw some to buy yourself a new motorcycle (for whatever reason, a favourite with advertising agencies showing active seniors in TV commercials these days), it won't change your eligibility for federal income-tested benefits and credits such as Old Age Security, Guaranteed Income Supplement benefits and the Goods and Services Tax Credit.

Besides, and that's perhaps the most attractive feature of the TFSA, if you withdraw money one year, you can re-contribute it next year.

The government has picked a nice-sounding name of a person called Gillian. In its literature, the government explains this feature thus: she's been saving $3,000 a year for 10 years in a TFSA, earning investment income on those savings, to boot. To start a small business, Gillian withdraws her TFSA savings, which have accumulated to $40,000. She doesn't pay a cent in taxes on this amount upon withdrawal. She then runs her business for 10 years. Afterwards, she's either bored, or she wants to retire to warmer climes, whatever, the government's literature is mum on this point, but she decides to sell the business. Now, she has cash in her hand again, and she'd like to re-contribute to her TFSA the $40,000 she had withdrawn from it 10 years ago. Guess what? No problem, and it won't affect her other available contribution room, either.

Nice or what?

Point by point:

• An RRSP is primarily intended for retirement savings. Tax assistance provided by a TFSA complements that provided through RRSPs.
• RRSP contributions are tax-deductible while RRSP withdrawals are added to income and taxed at regular rates.
• TFSA contributions are not tax-deductible but the contributions and the investment earnings are exempt from tax upon withdrawal.
• Unlike an RRSP, which must be converted to a retirement income vehicle at age 71, a TFSA does not have any minimum withdrawal requirement.
• There is no TFSA spousal plan. Individuals can provide funds to their spouse or common-law partner to invest in their TFSA, up to the spouse's or common-law partner's available room, and the income earned on the contributed amount is generally not attributed back to the spouse or partner who provided the funds.
• Check with your bank, credit union or other financial service provider before deciding whether to place money in an RRSP or a TFSA or to find out the combination of contributions that is best for your situation.

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