Tax Free Savings Accounts for Canadians

Jan 07

It’s January 2009.¬† And, do you know where your money is?¬† I’m guessing it’s not in your wallet, and worse, it may not even be in your savings account.¬† In fact, if you’re like the average Canadian, your money is tied up in paying off debt and you owe $9,000 on a line of credit and $2,400 on credit cards.¬† If we’ve learned anything over the past two decades, it is – spend now, pay later.¬†

In 1984, household debt (including mortgage and credit cards) equalled 71 cents of every dollar of income.¬† Fast forward to today and the debt has increased to $1.27 for each dollar of income.¬† The average Canadian today saves about 3% of their earnings (versus 20% in 1982.)¬† It’s no wonder new debt gets shovelled onto old debt.¬† With no savings to cushion unexpected expenditures (anything from car repairs to your pre-teen kid’s braces) the only option is to use a line of credit or charge it – and pray that somehow you’ll be able to pay it off… one day.¬†

TFSAs allow you to withdraw your money anytime with no penalty

The Canadian government is now offering an incentive to rebuild the savings that were lost over the past three decades with the new Tax Free Savings Account or TFSA (pronounced tifsa).¬† According to National Post , TFSA’s “were the biggest innovation and tax break since the registered retirement savings plan (RRSP) was introduced a half-century ago.”¬† And if you haven’t heard about it yet (it’s been written about in every newspaper), you probably also don’t know that you should stop buying $5 lattes at Starbucks and settle for a home brewed cup of java.¬†

As of now, January 2009, Canadians can open a TFSA and start earning money, tax free.

The plan is similar to a Registered Retirement Savings Plan (RRSP), so if you understand how they work, the TFSA is even simpler.  Here are the major features:

  • You must be at least 18 years old to own a TFSA.
  • You may invest in anything, such as a savings account, bonds, stocks, mutual funds, GIC’s.¬† Like RRSPs.
  • All dollars earned – either through interest or capital gains – are not taxed when withdrawn.¬† Unlike RRSPs (a tax-break is given when you contribute, then you are taxed on withdrawal.)
  • The contribution limit is $5000 per year, regardless of your income.¬† Unlike RRSPs (contribution room is based on income.)
  • If you do not contribute the full $5000 one year, the remaining amount is carried forward every year for the rest of your life.¬† So, if you put $4000 into a TFSA in 2009, you can put in an extra $1000 in 2010, or whatever year you have that extra thousand dollars to save.¬† Unlike RRSPs (there is an age limit to contributing.)
  • You can withdraw your money anytime you want with no penalty.¬† Need to purchase snow tires one particularly blustery winter?¬† Have to pay for your son’s speech therapy?¬† No problem.¬† Just dip into your TFSA and withdraw your necessary funds.¬† Unlike RRSPs.
    • The amount withdrawn is added to your contribution room the next year, so you can replenish that tire money later, in addition to your annual $5000 limit.
  • If you are in a single earner family because one spouse is at home with the kids, any income earned in a TFSA by the stay-at-home parent is not attributed back to the working spouse.

It’s so simple.¬† For families, the main benefits of a TFSA appear to be the steady availability of funds (versus RESPs and RRSPs), the income splitting opportunity, and the tax-free earnings to help save for big purchases (think house, car, private schooling.)¬† For more detailed and professional guidance on how to make the most of TFSA’s, you can buy a book written by Gordon Pape called (surprise!) Tax Free Savings Accounts.¬†

Now – how to cut back on your spending and actually acquire enough money to put in a TFSA?¬† You’ll have to figure that one out by yourself.

Financial Post has a number of with author Gordon Pape to further illuminate Canadians on the qualities of the TFSA.

Sources: National Post New TFSAs change a guru’s game plan by Jonathan Chevreau, MoneySense December/January 2009 issue

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One comment

  1. Thank you for an informative article on an important subject. The statistics on spending that you provide show a prime-example of how out-of-touch Canadians are becoming with their savings and spending. Hopefully being armed with information will help buck this trend in the near future.

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