Q: As a senior should I be contributing to the new Tax Free Savings Accounts (TFSA) or to a Registered Retirement Savings Plan (RRSP)?
A: OK, you all know the drill by now – the correct answer is “it depends”!
Benefits of TFSA Versus RRSP
The federal budget in 2008 gave all Canadians a terrific gift that made savings and income splitting easier. Beginning January 2009, investors 18 or older were eligible to open a tax-free savings account and allowed to contribute up to $5,000 per year. Contributions are NOT tax deductible, unlike RRSP contributions. If you are still working and in a higher tax bracket (earning more than $40,000 per year), it is more advantageous to make maximum RRSP contributions over contributing to a TFSA. In a perfect world your pockets are deep enough to do both.
Benefits of TFSA for Seniors
Especially attractive for seniors – you are able to re-contribute withdrawals and access funds without affecting eligibility for federally sponsored benefits such as OAS. Contribution room can be carried forward for future years (like the RRSP). While $5,000 isn’t a large sum, ten years from now, you will be able to shelter earnings on $50,000. Now that’s very useful!
How to Use Your TFSA for the Most Benefit
The big payoff for these accounts comes over the long haul. Don’t use them as short-term piggy banks. The investment growth or returns earned under the TFSA umbrella grow and compound free of tax and there is no taxation on withdrawal of the growth or of the initial contribution.
Retirees and TFSA
Those of us already retired or shortly headed into retirement should be using these accounts to shift investment assets we presently hold in non-sheltered taxable accounts into TFSAs as our contribution room permits. If we make “in kind” contributions of shares or other investments we already own, we will have to claim taxable capital gains on the contribution and will lose the ability to deduct the capital losses – just as with “in kind” RRSP contributions. Like an RRSP, when a capital loss is realized in a TSFA, it cannot be used to offset taxable capital gains.
TFSA Can be Used for Income Splitting
These accounts really shine as a solid income-splitting opportunity. Higher-income earners can give or “gift” the $5,000 TFSA contribution to a lower or no-income spouse or partner with no income attribution. Future investment earnings are earned in the lower-income spouse’s name and never taxed.
You Can Gift a TFSA Contribution to a Grandchild
If you have deep pockets and realize you won’t be able to spend it all before you “hit the exit ramp” you can use the TSFA to pass assets to the younger generation. You can gift a TFSA contribution to grandchildren over the age of 18 with no income attribution back to the grandparent. When the grandchild is sufficiently taxable they can withdraw the funds to make RRSP contributions and still retain the TFSA room for the future.
Make Sure you Have a Beneficiary Listed
From an estate perspective, there is a “deemed disposition” on the death of the TFSA holder but it is tax-free, making the estate larger than if these funds were held in a taxable account. TFSA clients can generally name a “successor holder” (only a spouse or common-law partner) or “beneficiary” on the account. Most provinces did not have the appropriate legislation in place when these accounts were first opened so be sure to sign a new application or be sure your intentions are indicated in your will.
Where to Invest Your TFSA
Like your RRSP, you can invest your funds in a savings account, GIC, stocks, bonds, mutual funds or ETFs. Statistics show that 94% of TFSA assets are currently concentrated in interest-bearing investments but a balanced approach may be a better way to utilize the tax sheltering.
Be Aware of Fees
Beware of fees. Some firms are charging administration fees as well as withdrawal fees. Look for no-fee deals, especially in the account’s early days. These account fees (as well as any interest expenses for borrowing funds to invest) are NOT tax deductible for a TFSA (also true for RRSPs).
Final Answer on TFSA vs RRSP
My final answer, if you have “earned income” there is a place for both RRSPs and TFSAs in your financial plan! No earned income? Focus instead on TFSAs.
About the Authors: Heather Compton has presented seminars on financial and retirement lifestyle issues for over 30 years. She retired as Vice President and Senior Investment Advisor with a major financial services company. Heather and husband Dennis Blas co-present retirement seminars for a variety of corporate clients and are the co-authors of Retirement Rocks! Canadian Boomers Invest in Life. You can find their book online or in independent bookstores. See more of their advice at Retirement Rocks.