By Brenda Spiering, Editor, BrighterLife.ca
The new federal budget tabled in the House of Commons on Tuesday increases the annual TFSA contribution limit from $5,500 to $10,000. That’s good news for Canadians. Whether you’re looking for a tax-sheltered way to save for a down payment on your first home or you’re getting close to retirement and looking for a way to supplement your retirement savings, the higher limit makes the account a more valuable option than ever before.
“Overall, I think the higher TFSA limit will encourage more saving,” says Cindy Crean, Managing Director of Private Client Services at Sun Life Global Investments. “It will also give people more choice in terms of which option is better for them, a TFSA or RRSP. For example, if Canadians think they will be in a higher tax bracket at retirement, a TFSA may be a better choice; with the higher limit there is also more room to save in a TFSA. In addition, retirees who don’t need all of their income can direct additional savings into a TFSA to shelter it from tax.”
Here are five additional ways you could benefit from the new TFSA limits:
1. Starting to save
If you’re just starting out in your career and still in a low income bracket, opting to save in a TFSA rather than an RRSP can make sense. While you won’t get a tax deduction for contributing to a TFSA, there is no tax payable on investment growth and you also won’t get hit paying tax when you draw the money out. And should you end up in a higher tax bracket in retirement, the tax deduction you get from contributing to an RRSP today could end up being less than the tax you will have to pay when you withdraw it. The higher TFSA limit means you can now put more into this one account, instead of having to look to an RRSP if you have more than $5,500 a year to save.
2. Saving for a home
A TFSA is a more flexible option for saving for a home than an RRSP. While the Canada Revenue Agency (CRA) does allow first-time home buyers to use the Home Buyers’ Plan (HBP) to withdraw up to $25,000 from their RRSPs, you have to repay it over a maximum of 15 years. And there are penalties: If you miss a payment, that amount is added to your taxable income for that year. TFSA withdrawals have no such requirements, and the increased contribution limit means they may provide you with enough savings room to cover the cost of a down payment.
3. Saving for retirement
TFSAs were designed to supplement RRSPs. If you’ve maxed out your RRSP, they provide you with another great way to shelter a portion of your investment earnings from income tax. And given that life expectancy has increased in recent years, the need to save for retirement has become more important than ever. Contributing additional funds to a TFSA can help ensure you won’t outlive your savings.
4. Funding retirement
If you’re nearing retirement and have substantial RRSP savings, you may wish to start contributing to a TFSA instead, to avoid a potential future impact on your Old Age Security (OAS) payments. This is because the CRA charges a special tax (or “clawback”) on your OAS payments if your net income exceeds a certain threshold (for 2014, the threshold is $71,592). As withdrawals from a TFSA are tax-free, they don’t add to your taxable income and have the potential for triggering this clawback in the same way as taxable RRSP withdrawals.
5. Working in retirement
According to the Sun Life Financial Unretirement Index, more Canadians expect to be working full-time than fully retired at age 66. If you’re one of them, there can be advantages to contributing to a TFSA over an RRSP, as TFSA withdrawals can be used to supplement your post-retirement earnings without pushing you into a higher tax bracket, the way RRSP withdrawals can.
Still, despite the benefits of the new higher TFSA limits, it’s important to remember that contributions to an RRSP provide the advantage of reducing your annual income tax. Assuming you’ll be in a lower tax bracket when you draw the money out than you were when you put the money in, an RRSP can help you save on the overall amount of tax you pay.
A financial advisor can work with you to help you determine the best options for your needs and personal situation.