Before I discuss using a TFSA to save for your child’s education I wanted to provide an overview of the Tax-Free Savings Account program.
First off, the Tax-Free Savings Account is not an actual savings account. Rather it is a vehicle to place investments into. Many different investment types are suitable, including mutual funds, index funds, exchange-traded funds, GICs, stocks, bonds, and savings accounts.
What does tax-free mean?
The money you deposit into a TFSA has already been taxed. Once that money is within a TFSA, regardless of investment type, there is no more tax to be paid; not on any investment gains, interest payments, and not when you withdraw it.
How much money will this save me?
Let’s start with discussing the TFSA limits. Starting in the year when you turned 18 or in 2009, whichever occurred later, your TFSA contribution room began to accumulate.
Here are the yearly limits as of today:
|Total to Date||$41,000|
This means that if you haven’t made any contributions to a TFSA yet, and were at least 18 in 2009 you currently have $41,000 of contribution room available.
If you had been maxing your contributions all along and had a balanced portfolio with a quite conservative return of 5%* you would now have about $47,000 growing tax-free. If your tax rate is about 30% that is a tax savings of $700 this year alone.
How can I get my money back?
Assuming your money isn’t locked in, such as in a GIC, you can withdraw your money at any time without losing your contribution room. This is one of the highlights of the TFSA compared to the RRSP. If you remove money from an RRSP you don’t get that room back.
What should you use the TFSA for?
Your TFSA can be used for anything. Often you may want to have a few different TFSA accounts for different purposes. You can have a savings account as an emergency fund or house downpayment, a balanced index fund portfolio for your child’s education, and more aggressive investments for your retirement if it’s still decades away. Use the TFSA to have different “buckets” for a variety of financial needs.
Who can use this program?
As long as you are over 18, a Canadian resident, and have a social insurance number (SIN) you are eligible.
Is a TFSA better than an RRSP?
This is a complicated question and the answer depends on your personal situation. But here are some of the benefits of the TFSA over an RRSP:
- The TFSA is not related to employment income. To contribute to an RRSP you had to have employment or a few other types of income within the past year. The TFSA isn’t tied to your income level or types at all.
- The contribution room doesn’t disappear. (Including all the gains on your investments.) If you remove $6000 from your TFSA you can put that amount back in the next calendar year. With an RRSP that room is gone forever.
- With a TFSA there isn’t withholding tax, or any tax at all on withdrawal. If you withdraw $10,000 from a TFSA that’s what the bank will give you. If you withdraw $10,000 from an RRSP they’ll give you $8,000 and send $2,000 to Canada Revenue on your behalf. Even if your income is below the taxable limit for the year, you have to wait until tax return season to get that money back.
- With a TFSA you never have to worry about your tax rate now or later. Generally an RRSP will only save you money if your tax rate at contribution time is higher than at withdrawal time. If you are at the start of your career and/or anticipate being quite rich in retirement you can possibly lose money by contributing to an RRSP.
What else should I keep in mind?
You do have to be careful to not to overcontribute more than the annual limit. If you have TFSAs at multiple banks make sure you maintain good records. You can find out your remaining TFSA limit from Canada Revenue Agency, but it isn’t instantly updated.
Also when you withdraw money, you must wait until the following calendar year to put it back in. Not waiting will result in an overcontribution (if you have already reached your limit).
Remember there’s no exact minimum contribution either (depending on your bank and investment type) so start moving your extra money into a TFSA today. An automatic transfer will make it even easier to take advantage of the savings.
The bottom line
For the average Canadian, between the TFSA and RRSP limits there’s no reason you should be paying taxes on any of your investment income or savings account interest. Remember those annoying tax slips with weird, usually small numbers? Once your extra money is all safely sorted into TFSAs and RRSPs you won’t receive those anymore. Tax time is easier and less expensive.
*This estimate is quite conservative. Many investors have had gains significantly higher than 5% in this time frame.