Yahoo Finance Clear the fog: TFSA dos and don’ts
Clearly, Canadians need to brush up on the benefits of Tax Free Savings Accounts (TFSAs) and how they work.
A recent survey by ING DIRECT finds many Canadians don't understand the rules of TFSAs. According to an Angus Reid Public Opinion poll commissioned by the bank, 23 per cent of Canadians believe their bank is responsible for tracking their TFSA contributions and withdrawals. Another 12 per cent think it's the responsibility of the government, while 7 per cent say their adviser is responsible for keeping track of TFSA transactions.
Moreover, Canadians only have a vague idea (37 per cent) or don't understand how TFSAs work (14 per cent), while 13 per cent don't know what a TFSA is.
"The Tax Free Savings Account is an invaluable tool when it comes to saving money for the future, but unfortunately many Canadians are unclear about the rules," says Peter Aceto, president and CEO of ING DIRECT Canada in Toronto. "One of the beauties of TFSAs is they're pretty simple. Yet, it seems much more Canadians than I thought are unaware of their existence and they don't understand how they work."
Concerning the confusion around how TFSAs work and who's responsible for overseeing them (you are tender reader), perhaps we're clinging to our colonial roots in our assumptions others will do it for us.
"I feel like I'm in the motivation business," he quips. Canadians do understand they have an obligation to save for their financial future he adds more seriously, "but there's a history of abdicating this responsibility to someone else."
To some extent though, the Canadian fog clouding an understanding of TFSAs comes down to apathy, he says.
Aceto also tells Yahoo! Canada ours used to be a nation of savers but we've gotten away from our banking heritage. He hopes 2012 — and TFSAs — will help spur a national return to socking away funds.
"There are a lot of Canadians who don't think they can find $25 a week to save for retirement," he says. "2012 needs to be a year where Canadian households begin to behave a little more financially responsible, get rid of debt and start saving for retirement."
Maybe part of the problem with TFSAs is the name of the product. "Tax-Free Investment Account" would have been more appropriate, because you can do much more than save. Then again, it might not be the name.
Who will benefit?
Crystal Wong, a senior regional manager with TD Waterhouse Financial Planning in Calgary, suggests Canadians aren't utilizing TFSAs due to a lack of disposable income.
"For those that do have the disposable income, especially those in a higher tax bracket, we would consider those individuals from a financial planning perspective that they contribute and max out their Registered Retirement Savings Plan contributions first," she says. "If they've already maxed out those contributions, then there's the ability to put the excess disposable income into a Tax Free Savings Account."
The difference between an RRSP and a TFSA, Wong says, is with the TFSA the limit continues to compound on an annual basis and withdrawals from a TFSA can be done without facing a penalty.
"Another strategy is if you have a spouse or partner that has little or no income and a very low RSP contribution room, regardless of age, the TFSA would be the vehicle that we'd recommend they put any savings into so it's tax sheltered," she adds. "Because it's a tax sheltered investment, the optimal investment to put into a Tax Free Savings Account is more of an equity-based investment such as equity-based mutual funds or an individual common stock or a dividend paying stock."
Mike Henry, senior vice-president, retail deposits, payments & lending, Scotiabank in Toronto, says many of his institution's customers have opened a TFSA.
"We have seen a good uptake in account openings year-over-year," he says. "Customers are making annual contributions either by lump sum or through monthly pre-authorized deposits and we have seen a lot of momentum building as more new accounts are opened each year and more consumers become aware of the TFSA, taking advantage of its benefits."
Henry also highlights the broad appeal TFSAs provide: It was originally introduced as a rainy-day account but it has a multitude of other uses be it for first-time homebuyers, retirement savers, or those looking for tax efficiency.
"There are no penalties associated with withdrawing money from a TFSA, however, the funds cannot be re-deposited until the following calendar year or over-contribution penalties will apply," he explains. "Each customer's situation is different so we are focused on offering the right advice about whether a TFSA or RRSP or both make the most sense for each individual."
For those who've yet to open a TFSA, there's contribution room aplenty. The current contribution limit for 2012 is $5,000. The federal government sets the contribution limit annually so future annual limits are subject to Ottawa's discretion.
"For Canadians who have not yet opened a TFSA, they have their full contribution limit available to them meaning individuals can contribute up to $20,000 in 2012, which would absorb their 2009, 2010, 2011 and 2012 maximum contribution limits," Henry says. "Do note that contribution limits vary depending on what province or territory one lives in."
TFSA dos and don'ts
Here are some dos and don'ts to keep in mind when managing your TFSA:
*DO keep track of your own contributions and withdrawals
One of the benefits of a TFSA is the ability to re-contribute money you've withdrawn from your account, though the re-contribution cannot be made until the following year. If you're making multiple contributions and withdrawals to your TFSA, it's important to keep records of your transactions so you don't end up over contributing to your account and being charged a tax penalty.
*DON'T treat your TFSA as a regular savings account
If you constantly make deposits and withdrawals to and from your TFSA, not only could you face over-contribution, but you also lose the opportunity to benefit fully from compound interest that is also tax-free.
*DO manage multiple TFSAs wisely
Canadians can have multiple TFSAs with more than one financial institution. But keep in mind the annual contribution limit is $5,000 per year for all of your accounts combined. So with multiple TFSAs, it's even more important to keep detailed records of contributions and withdrawals to prevent exceeding your limit.
*DO understand the tax implications of a TFSA
Unlike an RRSP, contributions made to a TFSA don't result in a tax deduction. Contrary to RRSP rules, you don't have to pay income tax when you withdraw funds from your TFSA. In addition, TFSA withdrawals don't affect your ability to qualify for income-based federal benefits, so you're not penalized for saving in a TFSA.
