Who will use Tax Free Savings Accounts?
The government introduced Tax-Free Savings Accounts (TFSAs) in the 2008 Federal Budget but will Canadians use these accounts? Will people be encouraged to save more money with the introduction of TFSAs?
Related article: TFSA Basics
Statistics show that people are not saving money but the hope is that the new TFSAs may help to change people’s savings habits. Up to 2013,
- 10.7 million Canadians with a TFSA (38% of eligible Canadians opened a TFSA)
- 1.9 million contributed the maximum (6.8% of eligible Canadians maximized contributions to the TFSA)
- $40.2 Billion was contributed to TFSAs in 2013
- $118.3 Billion was contributed to TFSAs since 2009
Who will use the TFSA?
The TFSA has been touted as the best thing since sliced bread. Personally, I think the TFSA is fantastic because it has universal appeal. TFSAs create a lot of new financial planning opportunities for Canadians to save money. Here are a few ways some people might use TFSAs in the future.
Saving to spend.
According to Financial Counselor Tricia French, TFSAs will make great accounts for not just long-term savings but also for short term spending. “I’ve seen too many people put a few dollars into an RRSP and then take it out after a few months. This behavior goes against how RRSPs should be used as it destroys people’s RRSP contribution room. TFSAs might be the best way to start a savings plan. At the end of the year, if they want the RRSP deduction, they can move it from the TFSA. TFSAs offer more flexibility when it comes to savings.”
Related article: Stop raiding your RRSPs before retirement
Savers will love having the TFSA especially savers who already maximize their RRSP and currently save in non-registered accounts. TFSAs have a clear advantage over known-RRSP savings for Canadians young or old. Savers in retirement will also benefit because they can still use TFSAs after the age of 71. Young savers will benefit from the magic of compound interest over the long term. TFSAs will especially benefit the ultra-conservative investors who like Guaranteed investments. Now holding GICs, Bonds, money markets and savings accounts inside a TFSA makes a lot of sense because you no longer have to pay tax on the interest. The TFSA is a great investment equalizer because you don’t get punished from a tax perspective by being conservative.
Related article: How much of your money should be conservative?
People with strong Defined Benefit Pension Plans.
Employees who belong to pension plans can find themselves with very little RRSP contribution room leaving them with little opportunity for long term tax-sheltered savings. TFSAs will give these employees another tax-sheltered vehicle for saving money.
Retirees avoiding clawbacks.
With respect to dividend income, although the dividend tax credit makes dividend income the most tax-preferred source of investment income, the dividend gross-up has the potential to create problems when it comes to income-tested programs and clawbacks. Now, holding investments that created dividend income inside a TFSA might help people avoid clawbacks on Old Age Security (OAS) and the Guaranteed Income Supplement (GIS).
Related article: Minimizing OAS Clawback
Interesting benefits for estate planning.
Sometimes significant non-RRSP accounts can trigger significant tax bills based on unrealized capital gains and other forms of investment income. Dying with RRSPs can also trigger significant tax bills at death. TFSAs are great for estate planning because at death the TFSAs trigger no tax. As a result, moving money from non-RRSP accounts to TFSA may help prevent big tax surprises at death.
Related article: Designating beneficiaries for RRSPs and RRIFs
In the future when TFSA plans have been around for a while and people build up their contribution limits, we may see some applications where people who get significant financial windfalls like an inheritance, for example, put significant amounts of money into TFSAs if they have the contribution room. If you do not contribute to a TFSA, you can carry forward the unused contribution room (much like an RRSP).
These ideas are just a few examples of how TFSAs might be used. This list is far from exhaustive since the opportunities for TFSAs are endless. It thinks French says it best “I can’t imagine very many who couldn’t find a use for it or benefit from it. I think this can be a benefit to anyone who wants to save and all they need is a little “tax-free” incentive. If anything I know I will benefit.”