One of the first things to consider in naming a product or service is to create a name that describes what the product does and what it is used for. In our opinion, this was the mistake made when the Tax-Free Savings Account (TFSA) was named. As is often the case, when someone doesn’t understand something they don’t care to use it. This has caused this valuable and important investment vehicle to be underutilized by many Canadians.
Officially defined, the Tax-Free Savings Account is an account that does not apply taxes on investment gains such as, interest earned, dividends, or capital gains within the account. This means that when you withdraw funds from this account no tax is withheld nor are you required to pay tax on any of these withdrawn amounts. TFSA’s are available to individuals aged 18 and older in Canada and can be used for any purpose.
Unlike RRSPs, deposits to a TFSA are not tax deductible – so you receive no benefits when filing your returns- however, your after-tax income is invested and will grow tax free. Again, unlike the RRSP, when you later withdraw the funds you pay no income tax . This is the key benefit of a TFSA - the ability to earn and grow your deposits tax free, yet it is all too often under-utilized by treating it as a true savings account with withdrawals and deposits the way you would in a traditional bank account.
Perhaps a better name for TFSAs would be Tax Free Investment Account or a No Tax On Returns Account. Investing for the long term and taking advantage of the tax exemption is what makes this product so valuable. Unfortunately for many without the proper financial advice, TFSAs are simply considered just a high interest bank account. Of course it doesn’t help that the big banks advertise better savings rates for these vehicles over a traditional savings account. What many don’t realize is that by constantly withdrawing and depositing you are ultimately losing the benefit of time and compounded tax free returns.
Let’s look at how TFSAs are different than the more widely contributed to RRSP product:
It is important to note we are not suggesting that contributing to an RRSP is a bad thing. Investing in RRSP's can be an extremely important part of an individual’s overall retirement plan. For example, contributing to the RRSP makes sense when your marginal tax rate at the time of contribution is greater than your marginal tax rate at the time of withdrawal. The key is for you to realize and understand there are other investment options available which can be more beneficial to your financial future.
At Insightful Wealth Group, we believe TFSA's can be an important part of your overall investment strategy. Regardless of whether you have a TFSA account (or many at various institutions) or have not yet opened one, we encourage you to call or stop by to visit us and discuss how to best utilize TFSA's for your personal situation. We can assist in opening or transferring your current Tax Free Savings Accounts as well as provide recommendations on how to invest your TFSA funds to meet your goals.