A tax-free savings account is a flexible and convenient savings solution that helps Canadians to earn tax-free income. This product can be used together with other investment vehicles such as registered education and registered retirement savings plans.
The Basics
There are multiple benefits to opening a TFSA, one being that consumers’ savings grow in a tax-free way while withdrawals and investment income are also tax-free. The fact that TFSAs allow flexible withdrawals is a further benefit for individuals. Another benefit is that there are no lifetime contribution limits to worry about provided that you are eligible. Finally, contributions to your TFSA account will have no effect on other government-provided benefits such as the Goods and Services Tax credit, Old Age Security, and others. With lifelong eligibility, this investment solution can be used at any age, whether you are a young professional or close to retirement.
What if You Are in the Middle Tax Bracket
Canadians with a high income level benefit from the new threshold or contribution limit ($10,000). Those who contribute the maximum will save about $3,800 in taxes over a 10-year period. With savings of about $5,000, those who fall in the middle tax bracket are making contributions of about 1/5 of their pre-tax income. At the same time, finance and tax experts point to the fact that the new contribution limit offers more flexibility, whether you are in the middle income bracket or have a more limited income. Even an income of $50,000 or lower makes the tax-free savings account a better alternative to the RRSP because TFSAs help save on taxes. Canadians who are about to retire may want to look into this option as well provided that they trim other investment solutions such as RRSPs and RRIFs.
In fact, the new limit is designed to benefit middle class couples. A couple in their early 40s, for example, is expected to accumulate savings of over $1 million over their lifetime, plus estate worth over $650,000. This is provided that both partners have an annual income of about $80,000 and aim to retire at the age of 58. Finance expects base estimates on a 3.5-percent real estate growth and 2.2-percent inflation. In general, a tax-free savings account is a good solution for young couples and professional in their early 30s if they are saving toward retirement or big-ticket items and other major purchases. Upper-class individuals will obviously benefit from the new limit, but the new measure is also designed for public service employees and teachers with defined benefit pensions and contributions they rely on. Young adults, on the other hand, may choose not to use RRSPs to save toward retirement altogether because of the tax issues associated with RRIF and RRSP withdrawals.
Is This Good News for Retirees?
Statements by the federal government indicate that retirees will be the major beneficiaries of the new contribution limit. To this, seniors may want to move cash from their RRSP or registered retirement income fund to a tax-free savings account. There are multiple benefits to doing this, one being that higher contributions reduce income tax. While many Canadians believe that it is not advisable to make RRIF withdrawals before the age of 71, this is not the case, especially for consumers with a registered retirement income fund. The fact is that individuals may benefit from early withdrawals by reducing their tax bill. In addition, there are estate planning benefits.
Some people are concerned that additional income will trim the benefits because they will be left with more taxes to pay. The good news is that this would be so only during the first couple of years once they retire. Then their taxable income becomes lower. The reason is that less cash in a registered retirement income fund means less money to which the minimum withdrawal applies. And while retirees pay more in taxes during the first couple of years, experts point out that there are several mitigating factors to take into account. One is that account holders pay at a 31-percent marginal tax rate which is lower compared to contributions from previous years. Thus Canadians benefit from the fact that they pay less in taxes on withdrawals.
Conclusion
There are plenty of benefits to opening a TFSA now that the contribution limit is set higher. All Canadians who are at least 18 years of age are allowed to contribute up to the limit and thus accumulate significant balances. These balances are not only conserved in a tax-free way but grow with time. Finance experts also point to the significant estate planning benefits offered by TFSAs. If one of the spouses was a RRIF holder and passed away, then the other spouse would suffer a major tax hit if they made RRIF withdrawals. With tax-free savings accounts, holders face less risk even if they make withdrawals early in retirement. And if you have $10,000, it is worth opening a TFSA and contributing up to the limit because this is a sheltered account. Some finance experts even advice customers to contribute to their grandchildren’s and children’s TFSAs in case they’ve already maxed out their own accounts. This is perfectly legal to do and yet another way to maximize your savings.
