Thursday, February 9, 2012

Tax Free Savings Accounts compared to RRSPs

A Tax Free Savings Account (TFSA) can be used as an investment account and is not just for savings

You can invest the funds in a TFSA in all of the same types of financial products that can be used in a Registered Retirement Savings Plan (RRPS) e.g. cash, GICs, bonds, mutual funds,segregated funds, exchange traded funds (ETFs), real estate investment trusts (REITs),options and warrants.

TFSAs are useful for both long term and short term savings as you can access the funds without any tax consequences. There are some major differences between a TFSA and an RRSP such as:

  • There is no requirement to convert a TFSA into a payment option at any age (i.e. RRIF)
  • Contributions to a TFSA are not tax-deductible and there is no related refund
  • Withdrawals do not result in lost contribution room - the same amount can be put back in the following year
  • Withdrawals are not considered as income for tax purposes and will not affect your eligibility for income-tested government benefits and credits such as the Guaranteed Income Supplement (GIS) or the Age Amount on your income tax return
  • Your contribution room increases by $5000 each year, independently of your earned income
Investing the funds in a TFSA and creating a profit will increase your contribution room even further if you withdraw those funds and then recontribute them in the following year. For example, if you invested $15,000 and made a profit of $15,000 you could cash in your investment, withdraw all of the $30,000 and thereby create contribution room of $30,000 to add to the $5000 room available for the following year. 

Of course, doubling your money is not so easy and investing in products that could give you this kind of return comes with considerable risk. Also, be aware that if your investments in the TFSA go down in value and you decide to cash in your investment, you would lock in your losses and decrease your contribution room available. Before deciding which products you will put in your TFSA you need to consider the time frame for your investment and how much risk you are willing to accept.

For more information on TFSAs visit Tax Free Savings Accounts and  Canada Revenue Agency TFSA facts