A post-budget TFSA primer

Adrian Mastracci, KCM Wealth

By Adrian Mastracci, KCM Wealth Management

Edited and reposted from the Financial Independence Hub with permission

Measures from last week’s Federal Budget gave the TFSA a healthy shot in the arm. As a result, many investors are wondering whether to pursue a TFSA or RRSP strategy. Quite simply, the TFSA, which started in 2009, complements your RRSPs and RRIFs so it need not be an either/or approach.

While you may think you already know everything there is to know about TFSAs, refreshing your knowledge of the basics can help you decide when and how to most effectively use your TFSA. What happens to your TFSA on death or marriage breakdown is particularly interesting.

How the TFSA works

Canadian residents, age 18 or older, who have a Social Insurance Number can open a TFSA.

TFSA contributions can be made in cash or “in kind.” The deemed disposition rules for “in kind” contributions are the same as those for RRSPs. Maximum TFSA deposits are as follows:

Year  Allowable Deposit

2009     $5,000
2010     $5,000
2011     $5,000
2012     $5,000
2013     $5,500
2014     $5,500
2015   $10,000*
* And annually thereafter.

The maximum 2015 deposit is $41,000 if you have not yet contributed to a TFSA. All unused TFSA contribution room can be carried forward indefinitely to future years. Over contributions will attract a 1%/month penalty.

You can withdraw funds from your TFSA at any time on a tax-free basis for any purpose. However, understand the plan withdrawal fees that may apply. The amount withdrawn can be re-deposited into your TFSA in a future year without impacting your contribution room. Neither income earned in a TFSA nor withdrawals will affect eligibility for federal income-tested benefits and credits such as age credit and the OAS clawback.

How the TFSA differs from the RRSP
An RRSP is primarily a savings vehicle for retirement. The TFSA can be used for practically everything. Both plans offer advantages, but they have key differences. Contributions to your  RRSP are deductible and reduce your income for tax purposes. In contrast, your TFSA contributions are not deductible. Withdrawals from an RRSP are added to your income and taxed at current rates. Your TFSA withdrawals and growth within your account can be withdrawn tax-free.

What happens on death or marriage breakdown
TFSA assets can be transferred to your  surviving spouse’s TFSA without affecting your spouse’s contribution room. Alternatively, yol can name your spouse as the successor to your TFSA account and maintain tax-exempt status. In case of a marriage or relationship breakdown, TFSAs can be transferred tax-free between spouses or common-law partners without affecting the recipient’s TFSA room. TFSA beneficiaries include your children who can receive estate distributions tax free. RRSP estate distributions to the same children would attract income taxes.

Benefits of saving in a TFSA
TFSA contributors will enjoy additional benefits as compared to saving in an RRSP or cash account. Capital gains and other investment income earned in a TFSA is not taxed. Furthermore, draws from a TFSA can be used for any reason. The full amount of withdrawals can be re-deposited into the TFSA in a future year. Only Lifelong Learning  and Home Buyer’s Plan withdrawals can be put back into the RRSP.

TFSA deposits make desirable saving tools, for say an emergency fund, particularly in years of lower incomes. The RRSP contributions make more sense during higher income years.TFSA deposits have no age limit. RRSP deposits end at age 71, unless there is a younger spouse.

It is apparent that TFSAs and RRSPs are both very useful saving vehicles, for different reasons.Understanding the differences will help you make better TFSA and RRSP decisions.

Adrian Mastracci, MBA,  is president and portfolio manager for Vancouver-based KCM Wealth Management Inc., specializing in designing and stewarding retirement portfolios. 

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