Introduced in 2008, the federal government has introduced a new investment vehicle, the TFSA. A TFSA is similar in many ways to an RRSP but will allow Canadians to save for other purchases, in addition to saving for retirement. The TFSA allows Canadians to save money in an eligible investment and watch those savings grow tax-free throughout their lifetimes.
An individual can save up to $5000 every year in a TFSA. This is in addition to their RRSP contribution room. TFSAs differ from RRSPs in such that, contributions to a TFSA will not be deductible for income tax purposes but investment income, including capital gains, earned in a TFSA will not be taxed, even when withdrawn. The chart below shows how one can compare a TSFA and an RRSPs growth and taxation.
| TFSA | RRSP | |
|---|---|---|
| Pre-Tax Income | $1,000 |
$1,000 |
| Tax (40% Rate) | $400 |
N/A |
| Net Contribution | $600 |
$1,000 |
| Investment Income (20 years at 5.5%) | $1,151 |
$1,918 |
| Gross Proceeds (Net Contribution plus Investment Income) | $1,751 |
$2,918 |
| Tax (40% Rate) | N/A |
$1,167 |
| Net Proceeds | $1,751 |
$1,751 |
| Net Annual After-Tax Rate of Return 2 (%) | 5.50% |
5.50% |
- Forgone consumption(saving) is $600 in all cases. In the RRSP case. the person contributes $1,000 but receives a $400 reduction in tax, thereby sacrificing net consumption of $600
- Measured in relation to forgone consumption of $600. Assumes annual nominal pre-tax rate of return is 5.5% invested for 20 years.
Source: Federal Budget 2008:
Some additional advantages of a TFSA are:
- Unused contribution room can be carried forward to future years.
- Withdrawals can be made at anytime for any purpose.
- The amount withdrawn can put reinvested back into your TFSA without having any affect on your contribution room.
- Contributions to a spouse’s TFSA are allowed and TSFA assets can be transferred to a spouse upon death.
