Tuesday, February 12, 2013

Don’t Use Your TFSA as a Savings Account

According to a recent post by Garth Turner, the gift, only 4 in 10 Canadians have a TFSA (Tax Free Savings Account). Of those only half actually do anything with it. In addition 80%  of people with a TFSA have it sitting in high interest savings accounts.

Garth writes:

“Despite being able to shelter all this money from any kind of tax, most don’t. Only four in ten people have a TFSA, even five years after it was created. Of those only half actually contribute to them. And (are you sitting?) eighty per cent of people with a tax-free savings accounts have the money in savings. Yup. High-interest savings accounts paying 1.5% or maybe two.”

Currently, Canadians are allowed to contribute a maximum of $25,500 to their TFSA. That’s $5,000 per year from 2009 to 2012, and $5,500 for 2013. However for all the benefits of the TFSA, the majority of Canadians are not contributing. That’s a shame, because the TFSA makes an excellent retirement investment account, and the best tax-sheltered deal around!

There’s More Than Just Savings

When the Federal Government introduced the TFSA (Tax Free Savings Account) back in the 2008 federal budget, most Canadians were simply uninterested in another government regulated savings account. Therein was the problem in the first place, because the name “Savings” was completely misleading. Many Canadians assumed and still do, that the only thing they can do with a TFSA is hold cash or a GIC at a paltry savings rate. They are certainly not getting the full benefit of compound growth with rates at 1.5%.

In fact, you can open a TFSA with your discount brokerage, such as Questrade or with your bank, and start trading any number of securities.** This includes stocks, bonds, mutual funds, or ETFs. ;)

The TFSA gives you investment options beyond simple low-rate savings. If you need short term savings then use a savings account. With all time low interest rates, you won’t be keeping pace with inflation, and the amount of taxable interest would be minimal. Nor would you be taking advantage of tax-free compound growth in your TFSA with a low interest rate.

The Golden Nest Egg

The real power of the TFSA is to use it as a retirement investment account. There are four main reasons:
  1. Tax free compound growth.
  2. Tax free withdrawals.
  3. No age restriction.
  4. No impact on government benefits.

Tax Free Growth and Withdrawals

First, all income can grow tax-free sheltered in the TFSA. That can include interest, bond payments, dividends, and capital gains, as long as it’s not foreign income. Second, you can withdraw any amount from your TFSA tax-free. That’s right, not only can you partake in tax free growth, you can also withdraw money from your TFSA at anytime you want. You can even contribute back your withdrawals in future years.

No Age Restriction

Third, there is no age restriction with the TFSA, unlike turning 71 with a RRSP. You can keep the TFSA until your 91 if you want to, and withdraw any amount you want tax-free. This is much different than converting your RRSP into a RRIF, where you have to withdraw a certain percentage, and then pay tax on those withdrawals. No need to deal with insurance companies and annuities either, unless you want to. That makes the TFSA simple and easy to understand.

No Impact on Government Benefits

Fourth, the TFSA golden egg comes from the tax-free withdrawals. While you don’t get a refund each year as with the RRSP, you do get a much better benefit in retirement. Since you didn’t get an immediate tax deduction when contributing to your TFSA, the government does not consider TFSA withdrawals as income.

This means, that any money withdrawn from your TFSA will not affect government benefits, OAS claw backs, or GIS (guaranteed income supplement). Here is what the official TFSA Pamphlet from the Government of Canada states:

“Your TFSA withdrawals and growth within your account are not included in your income—they are tax-free… Neither income earned in a TFSA nor withdrawals from a TFSA will affect your eligibility for federal income-tested benefits and credits, such as the Guaranteed Income Supplement and the Canada Child Tax Benefit.”

Having an extra income stream in retirement is a big plus. With the TFSA you won’t have to worry about taxable withdrawals or impacting government benefits. Let’s hope the government keeps it that way. ;)

Conclusion

The Government’s own TFSA Pamphlet, as well as the majority of banks promote the TFSA as nothing more than a savings account. Yet, the TFSA gives you a powerful investing account. In addition it gives you a powerful financial tool to generate tax-free income during retirement, without age restriction, nor an impact on government benefits.  The TFSA truly is a golden nest-egg for retirement. If you are only using your TFSA as a short-term savings account, then think twice. ;)

Readers, what’s your take? Do you utilize the TFSA for your retirement strategy?

Notes:
** The only things you can’t hold tax-free in your TFSA are foreign securities – such as U.S. dividend stocks. So if you do use your TFSA for dividend stocks, keep it Canadian.  Hold U.S. stocks inside your RRSP, since U.S. dividends will be tax exempt in the RRSP.  In addition, you cannot claim back the federal foreign tax credit for foreign securities inside the TFSA.

This article was written by Dividend Ninja. If you enjoyed this article, please subscribe to his feed [RSS]

0 comments:

Post a Comment

Recent Posts From DIV-Net Members