Revisiting The Tax Free Savings Account

In 2008, then Federal Finance Minister Jim Flaherty introduced the Tax Free Savings Account. “We already have a retirement plan. This is a savings plan for everything else,” he explained.

Perhaps that comment, as well as the name of the plan (not to mention the heavy advertising by banks), is the reason that most people are using the TFSA as a savings vehicle for near-term expenditures such as a new car or a home renovation. A high percentage of investment dollars continue to sit in low interest rate products such as GICs and high interest savings accounts (Globe and Mail).

Revisiting the Tax Free Savings Account

For building an emergency fund or short-term savings a TFSA is still ideal. However, now that it’s been around for a few years, it’s time to rethink its usefulness as an investment strategy to complement the retirement plan.

Related: Why TFSAs are still misunderstood

Anyone who was at least 18 years old in 2009 and a Canadian citizen can contribute to a TFSA, and you don’t have to have earned income or file a tax return. It may not have seemed like a big deal at first to deposit $5,000 a year, but now the full amount of contribution room is up to $46,500 (2016) or $93,000 for a couple – much more than you would need for most short-term goals or unplanned savings.

TFSA vs Home Buyers’ Plan

If you’re saving for a down payment on a home, the TFSA is a preferable alternative to the Home Buyers’ Plan. Sure, you get a tax refund from the RRSP deposit, but here are some of the conditions:

  • You are limited to a withdrawal of up to $25,000 ($50,000 for a couple) in one calendar year.
  • Your contribution must stay in the RRSP for at least 90 days before withdrawal.
  • It can only be used for a qualifying home that you must occupy as your principal resident within one year after buying it.
  • You have up to 15 years to repay and must start the repayment by the second year after the year of withdrawal.

In contrast, with a TFSA you can withdraw the total amount contributed plus any returns at any time and for any purpose, and it has a more flexible repayment plan.

Longer-term retirement purposes

Instead of thinking of a TFSA as a secondary investment vehicle with the bulk of savings going to RRSPs, reconsider the investments held within the account. Once portfolios start getting larger you can start thinking about longer-term purposes and increase the equity content in order to supplement your retirement savings in addition to short-term savings.

Historically, people were advised to wait to draw from RRSP/RRIFs as long as possible to have tax sheltered growth. Instead of waiting we should be drawing out smaller amounts of money earlier to smooth out and lower the overall taxes we pay year over year as recommended by Daryl Diamond in Your Retirement Income Blueprint, and still utilize the TFSA for further tax-free growth.

Final thoughts

According to a CIBC poll, many Canadians have no plans for the money they’ve been saving in their TFSA. But, you will get more out of it if you take some time to make plans for the funds you are investing.

Rather than letting your TFSA funds languish in a low interest account, think about how you can make the most of the tax-free benefits of this plan, both in the short-term and long-term.

Are you using it to the full advantage?

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  1. Jeff on September 14, 2016 at 6:56 am

    You might want to tweak the first sentence of your second paragraph since it implies that only Canadians 25 or older, in 2016, can contribute to a TFSA. Perhaps just change it to past tense.
    While no one can deny the flexibility of a TFSA, I don’t agree that it is superior to the Home Buyer’s Plan for individuals looking to buy a home someday. Your first two points can be addressed by using a TFSA in conjunction with the HBP. The third point is moot for those saving to buy their first home. As for the last point, the 15 year period for repayment, if that’s an issue then you’re probably not ready to buy a home. And the tax refund from the RRSP will help you save that down payment all that much quicker. Again, using both vehicles, the RRSP and the TFSA, will not only address all these points but the TFSA gives you a place to grow your money tax free if you’ve maxed out your RRSP contribution.

  2. Gert on September 14, 2016 at 7:57 am

    I agree with the above comments and wonder about the rates of returns on TFSA these days. My wife and I are struggling with buying a second home as an investment vs continuing saving. My RRSP are maxed as is my TFSA. Even though I’ve made max contributions to TF I only started investing it 3 years ago and it sits at about $50,000 (70% equity 30% fixed income). My mistake of not investing it sooner but I’m likely not the only slow learner. Some advice on how to invest for max returns would be appreciated.

    • Mick on September 14, 2016 at 10:56 pm

      For Gert: the rate of return in a TFSA is the same as in any other account type. It just depends on what you choose to invest in.

  3. Liz on September 14, 2016 at 11:35 am

    I believe you must also be a Canadian Resident, not just citizen. I was living abroad for the first few years that the TFSA came into existence, and though TD allowed me to open an account (because I was a Canadian citizen), it was later determined to be a mistake and the CRA was taxing my account 2% per month for “contributions over the limit” my limit being $0, as I wasn’t residing in Canada.
    Now that I’m back in Canada, I use a TFSA but my contribution limit is less than most people’s because of the years I was absent.

  4. K on September 15, 2016 at 5:55 am

    I believe one just needs be a resident to open a TFSA. Permanent residents and temporary foreign workers can also open TFSA as long as they have SIN.

  5. Madrigal on September 15, 2016 at 2:22 pm

    What is the status of a Canadian citizen who is studying full-time in the US, and thus only returns to Canada during the Christmas and summer vacations? Can he still invest every year in a TFSA?

    And what if he invested in the past when he was resident in Canada as well as a citizen? Can he keep those funds indefinitely in his TFSA without penalties?

  6. Judy on September 18, 2016 at 10:37 am

    For people that are going to be relying heavily on CPP, OAS and GIS for their retirement income, the TFSA makes sense as it doesn’t count as income.

    I have a portion of my TFSA in a HISA (1.75%), but with interest rates so low these days, it makes more sense to put it into my index funds, which is what I am planning to do at the end of this year.

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