Tax-free savings accounts (TFSA) may be increasingly popular, but they also have a lot of Canadians scratching their heads.
Forty-eight per cent of Canadians have a TFSA, up from 23 per cent in 2012, according to Bank of Montreal’s recently released Tax Free Savings Account (TFSA) report. However, there’s confusion surrounding the details: the poll found that just 19 per cent of Canadians know the annual contribution limit, 10 per cent have overcontributed since opening an account, and only 11 per cent can correctly identify the various types of investments that are eligible to be held within a TFSA.
“I believe TFSAs are not properly understood,” says Vancouver’s Laura Chanin, certified financial planner at HollisWealth Inc. “Many people believe that they can only be used to hold savings types of investments. This may be just a result of the name or that the public has yet to be fully educated about TFSAs. In reality they can hold the same types of investments as a registered retirement savings plan (RRSP): individual stocks, bonds, mutual funds, exchange traded funds, mortgage investments, and so on.”
Cash is the most common instrument being held in TFSAs (57 per cent), the BMO report found, followed by:
mutual funds (25 per cent)
Guaranteed Investment Certificates (GICs) (23 per cent)
stocks (14 per cent)
exchange traded Funds (ETFs) (5 per cent)
“In my experience, a large percentage of the population generally does not think about or want to really understand the details of their financial options,” says Calgary certified financial planner Kevin MacLeod, president of MoneyAdvisor.ca Financial Ltd. “People do generally understand what is advertised or promoted, and … the big banks advertise their interest-bearing TFSA accounts. So people put their money blindly in these accounts, and for some that’s fine.
“Tax free savings accounts are an excellent wealth creator for the right individuals and if used in the proper way,” he adds.
The specifics related to TFSAs may be murky because people compare them, often unfavourably, to RRSPs, which offer immediate tax savings and have a greater contribution limit, Chanin notes.
“If you are at a lower income bracket, about $30,000 or less, you’d be better off financially to save in a TFSA as opposed to an RRSP,” she says. However, people who have money sitting in an account will save all tax on the investment income earned by having it in a TFSA."
And there are other reasons why a TFSA just makes sense for savings, especially when it comes to your long-term retirement goals.
“If you belong to a pension plan, the amount you can contribute to an RRSP is minimal and may be better served in a TFSA,” Chanin says. “If you will earn a good income in retirement, you should definitely try to maximize your tax-free savings account contributions while you’re working. In retirement, paying for lump-sum expenditures such as a trip or a new vehicle by means of an RRIF or pension withdrawal can cause negative tax implications, whereas there would be no tax implications on a TFSA withdrawal.”
TFSAs aren’t necessarily for everyone, though.
“Generally, if someone has debt inside of a line of credit or any credit card debt that they are not paying off every month, they should not be utilizing a TFSA until these are paid off,” MacLeod says. “The interest they are paying on the debt will far exceed any guaranteed rate of return within a TFSA. Interest saved on debt is just as tax-free as interest earned in a TFSA.
“If your taxable income is over $87,123 you should generally try to max your RSP contributions first,” he adds. “If there are still some savings to put away, then a TFSA becomes the next best choice.”
The BMO study, conducted by Pollara, revealed that although the annual contribution limit is $5,500, TFSA holders plan to contribute an average of $3,625 this year.
And just how are TFSAs being used? Most often as a vehicle to save for retirement (47 per cent) and as an emergency source of funds (43 per cent), the BMO report suggests.