Benefits Of Tax Free Savings Account

2019/02/25

The Tax Free Savings Account or TFSA is a new form of saving account introduced by the government that allows the citizens freedom from taxes for any earnings in the account like interest, dividends and capital gains. You will be satisfied to know that even withdrawals are non-taxable.

The average American will find the principles of this account similar to the Roth IRA account. However, in TFSA accounts there are no limitations on the number of withdrawals. The introduction of this account has created a lot of stir among the people as it has been hailed as a good financial planning tool. However, critics have already pointed out that an average Canadian will find the benefits of a TFSA to be a very limited one.

Savings for Large Purchases

Many believe that this is the greatest advantage of this new account. If you want to save a large amount of money for your dream car or a payment for your house, then look no further; this is the account for you. Before the creation of this account, many people were forced to pay a marginal rate for interest earned by saving a large amount of cash. This rate was usually set at a whopping 30%. There were many who invested in dividend stocks to escape from high taxation but that was hardly a wise thing to do. These stocks are also taxable to a certain extend and there is the unwanted market risk too. So you might not get back the money when you need it most.

Emergency Fund

Many experts have opined that having a cash emergency fund is not at all a viable option for people who have a mortgage or a HELOC. But this new account gives you a shelter from paying high taxes on your interest. The experts believe that the interest that you get in this savings account is peanuts compared to the interest that you pay on your mortgage. So you can only be in a winning position if you have a large amount of emergency fund at your disposal.

Retirement Planning

It is very unfortunate that many North Americans are still not sure about the many benefits of RRSP account or Registered Retirement Savings Plan. The RRSP is still considered the best tax planning tool and an ideal plan for retirement. It is much superior to the TFSA. RRSPs are much better as the tax payable on contribution can be deferred and the tax on withdrawal is also very low.

There is a reason why RRSPs have not been very popular among the average Canadians. They believe that in order to maintain a RRSP, you need to be in a lower marginal tax bracket. However, this is far from the actual truth. People don’t understand that tax deferral = marginal tax on the entire contribution. For example, you have made $200k and you have contributed $20k as pre-tax income. If your marginal rate is 43% then you are actually deferring $8600 in taxes.

The fun doesn’t end here. When you are withdrawing this money in retirement, you are not paying the marginal rate on the withdrawal but the average tax rate. It is assumed that you have no other income. So this means that if you withdraw from your RRSP in retirement and if the marginal tax rate is same as it was at the time of making the contributions, then you are really saving a huge amount of taxes. It is often seen that you have actually saved more tax than what your average calculation shows. The main problem with TFSA is that it does not allow you to get so much benefit as you pay the marginal tax as soon as you earn.

Non – Registered Investing

The new TFSA is a welcome boon for those investors who have money in non – registered accounts. The new account helps them to reduce the amount of tax on their earnings from the investments. This is a far reaching improvement from earlier situations where the dividends and the capital gains had to be paid. This obviously means that the long term returns of the investments were severely affected.

Will It Benefit General Public?

Not many people save for future large purchases. There are many things like cars and vacations which people are used to buy on credit and they hardly go feel the need to save. Secondly, a handful of people do save but they are not really bothered about paying taxes on the interests.

Continuing from the above point, I can safely vouch for the fact that a majority of the people do not have anything by the name of emergency funds. Previously the high taxes did not permit the setting up of an emergency fund but with the introduction of TFSA, the scenario has changed. But still I doubt whether an average Canadian will be inclined to set up a TFSA. There are a majority of Canadians who still don’t save a lot for their retirement.

In fact, many people do not save at all. The TFSA is not ideally meant for retirement savings; so I doubt whether this new account will mean anything to them. But there is one piece of good news. To the average Canadian, the RRSP is very complex to them and they are not inclined to such a finance tool. But TFSA is easy to comprehend and people might just take it up as it is always a good idea to have something instead of nothing.

Who Will Benefit?

The main beneficiaries of TFSA will be the simple savers. People who are just satisfied with a simple savings plan and those who are retiring on benefits (the numbers are many!) are the ones who will benefit immensely from the introduction of this new account – TFSA. There are many people who are still not convinced by the benefits of TFSA but the financial experts, who are in favor of TFSA, are hoping that within a stipulated time people will understand its worth and apply for such an account.

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