TFSAs and your retirement
When Canadians turn their thoughts to retirement savings, it is the Registered Retirement Savings Plan (RRSP) that typically first comes to mind. This is understandable as the RRSP program dates way back to 1957 and remains a popular way for Canadians to build their retirement savings.
One of the primary features of an RRSP is that a contribution to your RRSP provides you with a tax credit. The amount of the credit is equivalent to the income tax you paid on the money deposited to your RRSP, up to your annual RRSP contribution limit. You claim this credit directly on your income tax return.
Introducing the TFSA
In 2009, a new savings program was announced by the federal government to provide Canadians with another savings option. Known as the Tax-Free Savings Account, or TFSA, this plan as I explained in an earlier Oaken Blog post, allows your savings to grow in your TFSA account and these earnings are not subject to taxes when you withdraw the money. This is a key difference between the two savings programs as funds withdrawn from an RRSP are fully taxed at your current marginal tax rate at the time the funds are removed.
Another thing to keep in mind is that you must convert your RRSP into some form of income when you turn 71. Options for doing this include simply taking the money in cash all at once, as an annuity, or by converting the money into a Registered Retirement Income Fund (RRIF). Take note, however, that the method you chose will have different tax implications and you should take this into consideration when determining the option that best meets your needs.
By way of contrast, you are not required to close a TFSA when you reach a certain age and you will not be required to pay any form of tax when you remove funds from your TFSA.
Saving for your retirement with a TFSA
While not specifically designed to help you save for retirement, under certain conditions a TFSA can be a very effective way to build your retirement savings. For instance, if you are younger and just starting your career, you’re likely in a lower marginal tax rate than you will be later in your career and potentially earning a higher salary.
Since unused RRSP contribution room is automatically carried over from year-to-year, you have the option to save unused contribution for later when you are earning a higher salary and are in a higher income tax bracket. This will increase the amount of your rebate when you file your taxes for that year.
Also, if you or your spouse are taking time away from work – such as for maternity leave, for instance – your salary will likely be lower during that time. Rather than making an RRSP contribution during your maternity time, you could save it for when you are back at work and earning your top income. This way you can receive a greater tax refund the following year. In the meantime, you can contribute to your TFSA to keep your retirement savings on track and to take advantage of the tax-free benefits of a TFSA.
TFSA contribution update
In late November, the federal government announced that the TFSA contribution limit for 2020 would remain unchanged at $6,000. This means that as of January 1, 2020, you can contribute up to $69,500 to your TFSA if you’re eligible to contribute every year since the TFSA was introduced in 2009.
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