Ellen Roseman: Tax-free savings accounts will change investing in Canada
- October 22, 2008 7:42 AM |
- By Ellen Roseman
Money Talks is a daily business column from CBC radio.
Ellen Roseman is a business writer at the Toronto Star.
The tax-free savings account arrives in just over two months. I predict life will never be the same for Canadian savers and investors.
You probably heard that the TFSA was introduced in the last federal budget. You can contribute $5,000 a year and you will never pay tax on the income.
Many people think a tax-free savings account protects only interest income. Think again. You can also avoid taxation on your stock dividends, mutual fund distributions and any capital gains you earn as a result of selling stocks or mutual funds.
I like the TFSA’s flexibility compared to an RRSP. If you take money out of an RRSP, you lose the contribution room forever. But if you take money out of a TFSA, you can put it back the following year - and still get another $5,000 in contribution room.
Moreover, withdrawals from a TFSA are not taxable and won’t interfere with your federal means-tested benefits. Let’s hope all the provinces to follow suit. This will be a big help to lower-income people saving for retirement.
Seniors are often dismayed to find out that RRSP withdrawals are fully taxable at the highest marginal tax rate. They forget about the big tax deduction they received when contributing to an RRSP. Now they tell me: “If I’d known about the high taxes on withdrawals, I would have saved more outside an RRSP.”
Does the tax-free savings account have a downside? Well, the annual contribution limit is rather low compared to RRSPs, but will be adjusted for inflation. You can carry forward your unused contribution room indefinitely, just as you can with RRSPs.
Also, you’re unlikely to get a tax refund for your TFSA contributions. If you love that extra jolt of cash flow from RRSP contributions to make purchases or pay down debts, you will be disappointed. An RRSP tax refund can also be leveraged to contribute to a registered education savings plan and get a 20 per cent federal top-up grant.
The TFSA’s major advantage, in my view, is that you can shelter capital gains and make them tax-free. Of course, you may only come to appreciate it once the stock markets settle down and you’re earning capital gains again.
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Comments (39)
This part of the last budget was ridiculed by the opposition as being of maginal value. The point needs to be made in the media that for the low income earners it provides a means to save for things they need or for their future. It magnifies their earning power while keeping them in the lowest tax brackets.
I have not seen attribution rules around TFSA's yet. I'm assuming folks with large families would like to set up a plan for every family member over 18 to get around the 5K limit as much as possible. Comments ?
What about the advantages of the TFSA as an estate planning device? There seems a big advantage there to sheltering savings from taxes, but there has been no mention of that from any source.
I wonder how 'alternative' banks will respond to the TFSA?
It is already near the end of October, and I have not yet received any information by the banks or other companies about how, exactly, the TFSA is going to be set up at their institutions. Why not? Is this hedging going on because the banks are afraid that the government is going to pull this program?
As a tax accountant (and before seeing the finer details of the plan) I will likely suggest to my clients not to bother with TFSA unless they have completely maxed out their contributions to their RRSP for the year.
There will be fees connected to these accounts. Banks have been working for some time organizing their marketing plans and sales packaging. They don't do that for free.
I presume you will not be able to deduct investment losses as you would if the account was outside the TFSA as per usual tax principles. That would be very painful to investors in today's markets.
I wonder, will there be big tax bills to pay when the taxpayer dies? Good things to know before getting excited about the plan.
In the 80's there was a simple one line deduction on the tax form -- every taxpayer could deduct the first $1,000 they earned from interest on savings. Simple and effective, no special plans needed & every saver large or small received the benefit.
I suspect the TFSA is a new marketing product invented by bankers but not as advantageous to as many taxpayers as the old $1,000 deduction was.
Oh, and expect more fees from your accountant unless you will be reporting on the ins and outs of the account yourself. Or paying the bank / stock broker to do it.
like RRSP - it's just an another gimmick to
bust our wonderful, succesful, a world safest,
fundemantelly sound bank system!
To Jeff C - attribution rules do not apply in this case. For TFSA's, the individual you are potentially providing money to is 18 or older.
Canada has had tax free savings accounts for years, simply check out the Bank Act and look for a "personsl deposit account". Here, let me help you... "personal deposit account" means a deposit account in the name of one or more natural persons that is kept by that person or those persons for a purpose other than that of carrying on business...
And here's what the Bank Act has to say about interest for a natural person's (ie not a taxpayer's account) PERSONAL DEPOSIT ACCOUNT
441. (1) A bank shall not open or maintain an interest-bearing deposit account in Canada in the name of any natural person unless the bank discloses, in accordance with the regulations, to the person who requests the bank to open the account, the rate of interest applicable to the account and how the amount of interest to be paid is to be calculated.
Just in case you need further clarification, let me help you... If you don't supply a SIN when you open the account and you tell the bank you want a "personal deposit account" as defined in the BANK ACT for purposes other than that of carrying on business, it can pay interest to you the natural person, tax free, because you didn't open a retail deposit account for the taxpayer... interesting eh?
Doug L
Financial institutions have been working on this since it was announced in the budget last year. There is plenty of information if you google TFSA.
The simple solution is to call your finacial institution and ask them about it. One point to ask them is "are there any administration fees to this".
The TFSA could be a usefull strategy for taking money out of an RRSP. You are going to pay tax on this money regardless of when you take it out. If you begin withdrawing these funds early enough the tax free compounding would help recover a portion of the taxes paid.
A big risk I see at the present time is some future Government cancelling the plan. Some politicians like to sniff out every $ they can find and tax it.
Wayne: I don't mean to sound like an ad, but I do know that ING is super excited about the TFSA. In fact, they are offering double interest (6%) until January to offset the taxes we do still pay on the interest until then.
This sounds like the ISA's in England. Always a good thing to have one of those kicking about.
Well there seems to be a benefit to those who can afford to put away $5000.00 each year. Many of us use pretty well all we make just to get by, day-to-day. Don't tell us about selling stocks and earnings from stock dividends. I guess Ms Roseman doesn't understand that many families just get by with what they earn.
Shouldn't it be pointed out that despite emotional responses to the income tax payable on RRSP withdrawals, you are still far better off with the up-front RRSP tax credit than simply getting untaxed savings growth?
Do some math and you will see you should be topping up your RRSP to the max before even contemplating a TFSA. When you finally do pay tax on your RRSP withdrawals, you will still get the basic personal exemption, deduct all your meds, etc., so you should definitely be paying a much lower tax rate than while you were employed.
You also get the benefit of years of untaxed gains on your RRSPs. If you also invest your tax refund, you will be doing even better.
The two should not even be compared really, I think the TFSA should only be used by those who are already at their RRSP contribution limit.
Everyone keeps talking about capital gains. How about capital losses? If you don't claim your capital gains, I am assuming that you cannot claim your capitals losses as well.
Being an independent broker in the financial services industry I have received a great deal of information regarding this new product. All of it from fund/insurance companies (Mackenzie, Equitable Life, AGF), but nothing from any of our bank partners. If you want the scoop on the TFSA talk to your non-bank affiliated financial planner.
How exactly is the TFSA of real benefit to low income earners? RRSP contributions have far greater benefit than TFSA contributions. Not only are RRSPs tax free, but you get a corresponding tax credit as well. When you consider that and then realize that low income earners can't afford to max out their RRSP contributions, it becomes quite clear that the only people who will truly benefit from this program are those who make enough money to max out their RRSPs first. Is the liquidity of the non-registered investment worth more than the tax break? Not likely.
Low income tax payer often have to make a choice between RRSP and TFSA, mostly due to the availability of extra money for saving.
In terms of tax, you will pay the same regardless of which account, provided you taxable income remain same when you invest and when you withdraw. With RRSP you will pay tax later, TFSA you will pay tax before you put the money in savings. Let us say you have a $1 to invest/save for a year at 10% interest and in 30% tax bracket. You will pay 0.30 tax for TFSA and invest $0.7 and earn $0.07 interest and have $0.77 at the end of one year. With RRSP you will earn $0.10 interest and and pay $0.33 tax and still have $0.77 at the end of first year.
Here are the differences:
1) RRSP is better in a sense, you take the government along with the risk you take in your investment. If you lose in RRSP, government loses too. TFSA, when you lose, it is all your money, and government has nothing to lose.
2) If your taxable income is going to be more than you income at the time of contribution, TFSA is better than RRSP.
3) If you want to save for (or don't have savings for) rainy day, TFSA is better option compared to RRSP, since there is less restrictions.
The TSFA's have resulted in creating another huge bureacracy to administer them, including tax receipts, fees, and staffing at the banks and the government to explain how they work to the public. Wouldn't it have been easier (and cheaper) to have just made the first $100 in interest earned tax free on your tax return. No muss, no fuss. The tax returns can be adjusted each year for accumulated interest without creating another marketing monster at the banks in the fall and winter, like the RRSP circus in February and March. But I guess there would be no money in it for the banks that way, and no one pays attention to income tax adjustments when government's release their budgets, only "goodies".
TFSA if it takes off I believe more people will put the money in this financial instrument. The only disadvantage it has, you don't get the big tax break of a rrsp. But most people are unable to maximize their rrsp contributions, to fully reap the tax break.
TFSA sounds great. You can take the money out, put it back in and no penalties. I love it.
TFSA accounts are not as 'easy' as they appear. When saving for retirement, use your RRSP first then TFSA but always keep a non registered plan.
Watch the account set up and death beneficiary information for the TFSA, it is not like an RRSP in this respect.
If TFSA were open to help low income families save, why don't they issue reciepts to benefit everyone on their taxes?
The reason people have a hard time with the tax on withdrawals of RRIFS is because they did not save enough in them to begin with. Minimum RRIF payments are NOT taxed. As well, many retireees don't always scale back their spending, live longer than 80, want more 'stuff', redeem earlier than retirement age (72) etc.. so they run out of money faster.
While the TFSA looks good, if a low to mid income family can put $5000 in an account that gives nothing back, why not put it in your saving account, in and out redemptions are permitted in there too and most often, you won't lose your money.
Hugthetaxman.ca
ING Direct TFSA with NO fees. This is what I plan on using.
One other example of why TFSA over RRSP...
I'm currently earning a relatively low income, but I expect to earn more later in life. Rather than maxing out the RRSP with minimal tax savings, I'm better to save the contribution room for when I'm at a higher tax bracket, and use a TFSA now.
I can't see much benefit in this, except to the financial institutions. Most lower income people will never be able to save $5000/annum, and the returns are too minuscule for the rest of us.
I agree with the poster who suggested that this was the government helping the financial industry with its marketing.
A few points here:
1. I don't see where there would be any capital losses from a savings account.
2. I ran some numbers in a spreadsheet, comparing $5000 per year in each of these products for 20 years. Assuming the RRSP gets an average return of 8.5% and the TFSA gets 4.5%. I also assumed a 30% tax hit at the end of 20 years on the RRSP. Assuming that you re-invest your tax savings back in to your RRSP, you'll end up about $40,000 ahead (after tax) with the RRSPs. However, most people don't put their tax rebates back in to RRSPs.
Doug L: The opposite of "natural person" is "corporation", not "taxpayer."
Larry: Well of course if your model gives the RRSP a return of 8.5% and the TFSA 4.5%, the RRSP will come out ahead. But since you can put the same products in a TFSA as an RRSP, why would you use a lower rate for the TFSA?
Anyway, I'm all for the TFSA. I max out my RRSP contributions every year, so the TFSA works great for me. Plus ING Direct is already selling TFSA's (indirectly: they're selling something that they'll convert to a TFSA on Jan 1), and even giving double interest until the end of the year.
if you go to ing.com you can learn about this type of savings account and the fact that you can open more than one tax free account sounds worth it doesn't it
Darcy, BC - In the Bank Act the opposite of a "natural person" is an entity. ("person" means a natural person, an entity or a personal representative;) An entity is an artificial person. If you open a bank account with a SIN, you're opening it for the benefit of an artificial person/entity known as a "taxpayer", that's why the bank sends you a T5. Contrary to popular belief, we human beings are not "taxpayers", however, most Canadians unknowingly act as the legal representatives of a "taxpayer", which is an artificial person.
Every bank along with the CRA website have lots of information on the TFSA. It is worthwhile to check out some of the information to help clear up the misconceptions that are out there!
A lot of people are using the phrase 'tax free' when describing the RRSP. It is NOT 'tax free' rather 'tax deferred.'
A true comparison of one vs the other would be looking at how much you'll have at the end of your investment AFTER the RRSP taxes are paid.
The TFSA should be seen as a positive step by the Government to encourage people to save. Two big questions I have deal with taxation to a beneficiary and potential administration fees charged by the institution. These questions will be answered as time goes on.
Many posters have questioned the ability for many people to save 5000.00. This to me is a non-issue. How many many people contribute the maximun to an RRSP?. We put away what we can. It makes sense to me to build up a non-registered, non taxable reserve for a rainy day.
You're missing the point Bruce. The TFSA was flogged by the neo-cons as a great win for the working man. As some kind of proof that they're looking out for the lower and middle classes. It's all BS, hardly anybody from that economic group can benefit from it. If you actually can benefit from the TFSA, you didn't need the help to begin with. It's nothing more than a tax break for the rich, disguised to make it more palatable for the rest of us.
The dishonesty that rules politics is disgusting.
Spinney
This is a savings account in which the internest, growth and dividends accumualte tax free. The is no tax deduction. How do you come to the conclusion it is a tax break for the rich.
Sorry Spinney.
I did not miss the point. I don't think you have looked into the TFSA. If you had , you would not be referring to it as a tax break for the rich.
My thought is that if I can buy stocks in a TF
SA, I can grdually sell my income trusts that are making high interest and buy them again in a TFSA. The government will benifit from Capital gains or maybe I will benifit from the current loss at this point, buy them back and have the future income tax free. This down turn in the market may be a good time to switch?
Is there a way that I can turn some of my investment losses into
a way to lower my tax bill in 2008?
The TFSA are great, but how about about almost no limit on the amount you can tax shelter and can access tax free? It's called participating whole life it's been around over 100 years in Canada and the insurance companies that offer it have paid a dividend every year with out fail (usually 2 to 3% higher than the best 5 year GIC. Do your own research...type it in google.
Why do most people not heard of it? When the media tells you that the market is up 20% (in years gone by)getting 5-9% rate of return sounds like a joke. Now that the TSX is down about 40% this does not look so bad.
regards,
Brian Poncelet, CFP
The TFSA is for the wealthy.
Max your RRSP then take the $5Grand and buy some cheap stocks under the TFSA.
Double or triple it within a few years, and reinvest. If you lose it, so what. Either way you're wealthy.
I have a tax free account with ING Bank.My broker now tells me they are more flexible with what they can do with this money. Can I cancel my Ing account and transfer My investment account? Or is that a good idea? John Abrams