TFSA limit rising to $5,500 in 2013

Tax-free savings accounts just got a bit more attractive to Canadian savers and investors -- too bad the $500 increase will likely go ignored.

The federal government announced Monday the TFSA contribution limit will rise from $5,000 to $5,500 beginning Jan.1, 2013. This is the first time TFSAs have been indexed for inflation, which occurs in $500 increments, the government said.

"Our Government remains committed to our low-tax plan for jobs and growth and we are very pleased to offer Canadians ways to save on taxes and keep more of their hard-earned money," Ted Menzies, minister of state (finance) said in a release. "TFSAs have become an exceedingly valuable savings tool for so many Canadians."

The government even released a handy chart to demonstrate the benefits of the tax-free account, stating: "A middle-income saver could accumulate about $2,340 more in tax savings on their investments than if the additional investment had been made in a taxable savings vehicle (unregistered account)."

TFSAs not understood

Unfortunately, the change will likely go for naught. Canadians have largely ignored the tax-free perks because many feel the rules governing them are too complicated.

Fifty-three per cent of Canadians have not opened a TFSA account, according to a recent survey conducted by Angus Reid on behalf of ING Direct Canada. A mere 44 per cent said they had only a vague idea of how a TFSA works, while an additional 19 per cent said they were totally clueless about them.

In a separate survey by ING Direct Canada, 13 per cent of respondents had no idea what a tax-free savings account was, while nearly half of those surveyed believed someone else was responsible for tracking their annual contributions.

According to the federal government, 8.2 million Canadians having opened an account, but approximately only 2.5 million contributed the maximum $5,000 in 2011. Perhaps we're spending too much servicing our record debt loads?

Canada's debt-to-income ratio has reached a record 1.63 per cent, meaning for every dollar Canadians make, we owe $1.63 in debt -- both secured and unsecured. Coupled with mortgage payments, childcare costs, RRSP contributions and household expenses, it's no wonder Canadians are finding it difficult to cough up an additional $5,000 of annual savings.

But if they can, they should.

How TFSAs work
Anyone over the age of 18 can open a TFSA, which can not only function as a savings account, but can also serve as a vehicle to hold investments -- mutual funds, GICs, stocks, etc.

Any interest or capital gains (money received when you sell securities at a profit) can be sheltered in the account, meaning your money can grow tax free. And any withdrawals from the account are not taxed.

Contribution room can be carried forward to future years, which is great news for those Canadians without a TFSA -- they can now contribute $25,000 when they open an account and watch those funds grow tax free.

And any withdrawals made in the current calendar year, will enable a higher contribution rate next year. For example: If you deposit $5,000 to a TFSA in April 2012, but withdraw $2,000 in October 2012, you'll be able to contribute $7,500 in 2013, which includes the additional $500 announced on Monday.

For more on tax-free savings accounts, visit the federal government's TFSA website.