The Canada Revenue Agency has announced that Canadian adults will be able to add an additional $ 6,000 to their Tax-Free Savings Account (TFSA) in the new year.
The amount is consistent with previous years, but is determined by Ottawa from year to year. As Canadians consider adding to their TFSA, there are some key features of the investment vehicle that should be kept in mind.
Funds can be withdrawn at any time and investment returns – whether it’s capital gains on stocks or dividend income and fixed income – are never taxed.
In comparison, half of the capital gains on non-registered accounts are taxed and the income is fully taxed. Dividends are also subject to full taxation with the exception of a tax credit on qualifying payments.
The federal government introduced the TFSA in the wake of the 2008 global financial crisis and the ensuing market downturn in an attempt to encourage Canadians to return to the financial markets. Since then, eligible contribution levels have increased each year. As of January 1, the total contribution limit for anyone aged 18 or over in 2009 is now $ 75,500. Inflation-adjusted contribution limits are expected to continue to rise in the years to come, even if Ottawa gives no guarantees and increases could end at any time.
Contribution space from TFSA withdrawals can be reclaimed the following calendar year. Excess contributions are subject to penalties from the CRA. If you want to know your personal limit, the CRA provides them in an annual notice of assessment on personal income tax returns and for individuals who open an online CRA account. A word of warning: Contribution limits posted by the CRA are generally for the previous year, so be sure to include contributions made in the current year.
From a tax standpoint, what comes closest to a TFSA for the average Canadian is the principal residence tax exemption, which allows Canadians to avoid paying any capital gains tax they may have. they generate from the sale of their main residence.
The TFSA was originally designed as a short-term savings tool, but over time has become a potential tax savings dynamic in retirement when used in conjunction with an RRSP.
While contributions to an RRSP can be deducted from current income, those contributions – along with the returns generated over the years – are fully taxed when withdrawn in retirement.
Just like the TFSA, the RRSP can hold just about any type of investment, including stocks, bonds, mutual funds, exchange traded funds, real estate investment trusts, and even options.
It is important to note, however, that non-Canadian dividends are subject to withholding tax on behalf of the United States Internal Revenue Service (IRS). This includes large blue chip American corporations. It also includes US mutual funds or exchange-traded funds (ETFs), and even Canadian mutual funds and ETFs that hold US stocks.
Both investment vehicles have the ability to generate tax-free returns over long periods of time. But unlike TFSA withdrawals, RRSP withdrawals are taxed as income. If RRSP savings increase too much, retirees could end up in a high tax bracket and even be forced to make minimum withdrawals that could result in Old Age Security clawbacks.
With good planning, the TFSA and the RRSP can complement each other. Over time, RRSP contributions can be limited to limit retirement withdrawals to the lowest marginal tax bracket, and TFSA withdrawals can provide the rest of the income needed in retirement.
It’s hard to know how to keep this balance, but a popular strategy is to contribute to an RRSP and put the tax refund into a TFSA. Contributions can be monitored and staggered over time as needed.
The RRSP contribution deadline for those who want to lower their tax bill for 2020 is March 1, 2021. That leaves plenty of time to develop a strategy that will put more of your taxes in your pocket in retirement.
Payback Time is a weekly column written by personal finance columnist Dale Jackson on how to prepare your finances for retirement. Have a question you want to answer? Email [email protected]