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Product 411 - What are the pros and cons of a tax-free savings account?

At a time when the cost of everything is rising – groceries, real estate, shipping costs and pretty much everything else – why pay more tax than you absolutely have to?
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What are the pros and cons of a tax-free savings account?

It’s with that sentiment in mind that we’re exploring the Tax Free Savings Account (TFSA) and more importantly, its pros and cons to help you determine whether it’s the tax savings strategy you need.

What is a TFSA?

The TFSA program was launched by the Canadian Government in 2009, essentially as a way for anyone 18 or over with a valid social insurance number (SIN) to save money without paying tax on it. When these funds grow or are withdrawn, it’s generally tax-free. However, contributions are not income tax deductible. The most popular of tax-sheltered accounts, TFSAs are used by more than 5.5 million Canadian households. You can check your annual contribution limit by logging in to your online CRA portal.

Pro #1: Grow your money tax-free

When you place your savings into a TFSA, your investment grows without incurring tax. This allows it to compound much more quickly. Simply contributing a few thousand dollars each year can grow it to a few hundred thousand over a 40 year investment period, all tax-free. It’s also intergenerationally transferable upon death tax-free, leaving your hard-earned savings to your family and out of the government’s grab.

Con #1: No income tax advantage

The flip side of this equation is that TFSA contributions are not income tax deductible. It’s for this reason that those in higher-earning income brackets often leverage the Registered Retirement Savings Plan (RRSP) rather than the TFSA.

Pro #2: Barrier-free withdrawal

There’s a beautiful sense of freedom associated with the TFSA in that you control your access to your savings and can withdraw from the account when you choose to do so and without incurring tax. Unlike the RRSP’s mandatory annual withdrawal rates after age 71, the TFSA does not force withdrawals in your lifetime. Even better, when you do withdraw from your TFSA, it’s not classified as income and won’t affect any other government benefits program you participate in.

Con #2: Easy-access withdrawals

Unfortunately, there is a negative to the barrier-free withdrawal of the TFSA. It’s almost too easy, which can make it vulnerable as a savings strategy should you become tempted to dip into it along the way.

Pro #3: Open contribution allowances

One of the things that make the TFSA attractive, particularly to couples and families, is the openness within the regulations around contribution allowances. For one, whenever you withdraw from the TFSA, the opened contribution space is made available once again the following year. Second, the contribution allowance is the same no matter your income, making the TFSA especially attractive to earners in the lower or moderate-income brackets. For the average Canadian household, over 30 per cent of their income can be sheltered in these accounts. Third, the TFSA’s contribution space is sharable with your spouse so you can maximize your tax-sheltered savings as a partnership to realize the most benefits.

Con #3: Creditors can go after your TFSA

Hopefully you never have to worry about this TFSA-associated con, but life happens and it’s important to realize that these savings are not protected from creditors. That means should you go through a bankruptcy, lawsuit or collection, unlike RRSPs, your TFSA holdings can be seized. Experts recommend protecting your TFSA contributions with proper insurance.

CPC-logoThis story was made possible by our Community Partners Program. The editorial content and views expressed in the articles are not those of and the Alberta Securities Commission. Learn more.
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