The 2015 federal budget, announced in April 2015, included a significant increase in the TFSA contribution limit for 2015. While it’s possible to argue that the changes really only benefit wealthier Canadians who can now tax-shelter more of their assets, there is also a strong argument for the fact that the increased TFSA limits can also benefit those Canadians in the lower tax brackets.
TFSAs (Tax Free Savings Accounts) were first introduced back in 2009. Canadians were allowed to contribute up to $5000 each year from 2009-2012 and up to $5500 each year from 2013-2014. As with RRSPs, any unused TFSA contribution room can be carried forward into future years but unlike RRSPs any money withdrawn from TFSAs can be replaced in the following calendar year.
Related article: Understanding the basic of TFSA contributions and withdrawals
TFSAs became even more powerful in 2015 when the government announced in the federal budget that the contribution limit was increasing from $5,500 to $10,000 per year, with immediate effect. Unfortunately for those that love the TFSA, this annual increase was shortlived as the new Liberal Government reduced the annual limit back to $5500 for 2016. This means that any Canadian residents who were over the age of 18 in 2009 (and resident in Canada) and who have never contributed to a TFSA currently have a total of $46,500 in contribution room for 2016.
Advantages of TFSAs
While contributions don’t generate a tax deduction, what makes TFSAs so attractive is that any growth on those contributions is tax-free. Our financial institutions have done an excellent job over the past few years of promoting TFSAs as savings accounts, often offering higher rates of interest than their regular savings accounts to entice consumers to sign up. However with interest rates being so low, the tax-free growth available through TFSAs is often dismissed as having little real value. Many people don’t realize that, because you can hold investments such as bonds, stocks and mutual funds in a TFSA as well as cash and GICs, they have the potential to be very powerful savings vehicles.
Related article: How to invest your TFSA?
Critics of TFSAs suggest that the recent increase will only really benefit wealthier Canadians who have the ability to save more but, because contribution room can be carried over into future years, there are benefits for lower-income Canadians too.
Related article: Who benefits from the TFSA?
TFSAs vs. RRSPs
There has been a debate raging ever since TFSAs were introduced as to whether they are a better savings vehicle than RRSPs. Both RRSPs and TFSAs have their advantages and their disadvantages and which one is better really depends on the goal for the money and the income level of the contributor. People in a higher tax bracket who are saving for retirement will benefit more from the deferred taxation available through RRSPs than those in a lower tax bracket. Anyone planning to use their savings while they’re working is likely to benefit more from the tax-free growth and withdrawals available in a TFSA than from the initial tax-savings that you get with RRSP contributions.
Related article: TFSA vs RRSP – the new debate
There’s no rule of thumb that puts one account ahead of the other; they each have their advantages and disadvantages but understanding how each one works and how each can help you reach different savings goals will allow you to better decide which account to use for your goals. With TFSA limits likely to increase again in the future, having more opportunity for tax-free savings can only be a good thing.