Can you use a tax-free savings account to save for retirement?
Absolutely! A tax-free savings account (TFSA) is not only good for your shorter-term goals (e.g., a down payment, vacation, wedding, or even an emergency fund), but it’s also a great way to save for retirement and manage your money when retired.
The key benefit is right there in the name: tax-free. Because you’ve already paid tax on the money you put into your TFSA, you don’t have to pay tax on it when you take it out.
Plus, to encourage Canadians to save in TFSAs, the Federal Government exempts any investment or interest growth in your account from tax, too. Let’s say you’ve earned 6% on $10,000 in your TFSA. That’s $600 earned that you don’t pay any tax on. Assuming a tax rate of 25%, that’s $150 more in your pocket!
Know your limits: TFSA versus RRSP
As for contribution limits, the maximum you can put in a TFSA per year is usually a lot lower than your RRSP limit. Regardless of your income, the maximum you can put in a TFSA is $6,500 for 2023. Your RRSP contribution limit is 18% of your previous year’s earned income, up to a maximum of $29,210 for 2022 ($30,780 for 2023), minus any pension adjustment.
How much impact can a TFSA have? Let’s assume that you had contributed the maximum each year since the TFSA was introduced in 2009 (and that you were at least 18 when you started). Your TFSA would now total $70,500 plus investment growth, which could easily push it over $100,000. And that’s just in 11 years. Imagine what your TFSA could look like in another 10 or 20 years!
If you feel like you’re a bit late to the TFSA party, you can play catch-up for every year you were eligible as far back as 2009. And so far, the government has been raising the TFSA contribution limit every few years. If you keep contributing faithfully, chances are your account will grow significantly over time.
What are the benefits of a TFSA in retirement?
A flexible TFSA can come in handy at any age, but it’s particularly useful in retirement for several reasons:
Cash from a TFSA isn’t taxable income.
Non-taxable means a TFSA doesn’t trigger the Old Age Security (OAS) pension recovery tax, a.k.a. The Clawback. The government starts “clawing back” your OAS payments on a sliding scale as your income nears an upper threshold. For the 2022 income year, you must start giving back some of your OAS when your income reaches $81,761. You have to give back your entire OAS payment if you income is over $134,626 (for ages 65 to 74) or $137,331 (for ages 75 and over). You can take money out of your TFSA without fear of it pushing your income into clawback territory.
If you want to save money tax-free in retirement, a TFSA may be your only option
You don’t need to have earned income in the previous year to put money in your TFSA. With an RRSP, you do. In retirement, income typically comes from some combination of CPP and OAS, a RRIF, a company pension, and other investments. All that is considered taxable but not earned income. You can keep your RRSP open until you’re 71, but you can’t put anything into it after you retire.
You can take money out of your TFSA without being taxed
That makes the TFSA unlike all other registered and non-registered investments. You never know when an expensive emergency – or an attractive opportunity – might suddenly come up. When desired, you can dip into your TFSA without worrying about losing a big chunk of it to the tax department.
You’re allowed to refill your TFSA the year after you take money out of it
And that refill can be over and above the contribution limit for that year. By comparison, once you’ve taken money out of your RRSP, you never get that contribution room back. And once you open a registered retirement income fund (RRIF) with money from an RRSP, you can only take money out. You can’t put money in, except from another RRSP.
You can keep as much in your TFSA as you want, for as long as you want
That’s freedom does not apply to an RRSP or a RRIF. You have to shut down your RRSPs by the end of the year you turn 71. If you turn your RRSP into an RRIF, LIF or LRIF (the last two being for locked-in RRSP money), you must take a minimum percentage out every year and that percentage increases over time. At 65, you have to take out 4% of the balance. By 95, you have to take out 20%. As well, there are withdrawal maximums for LIFs and LRIFs. With a TFSA, however, you’re fully in charge.
It’s a smart place to put spare cash
Some years, the minimum RRIF/LIF/LRIF withdrawal may be more than you need. A TFSA is a good place to park that money and watch it grow, without incurring tax.
It’s easy to leave your TFSA to your spouse
To do so, simply name your spouse as the “successor holder” on your account. That way, the TFSA passes seamlessly to your spouse upon your death. There will be no taxes to pay and no effect on your spouse’s TFSA contribution room.
Ken Seibel, MBA, CFP, RIS, is an investment advisor with Meridian Credit Union. He says the best way to use your TFSA in retirement is to draw from it to level out your taxes. “Your taxable income sources, like pensions and RRIF withdrawals, could reach a point where your marginal tax rate is going to increase,” Ken says. “It could even be as high as it was while you were working. If you need more money, consider tapping your TFSA funds to keep your taxes down.”
What can you put in a TFSA?
We’ve covered taking money out of a TFSA – but what can go into it? That is, what kind of investments can you own in your TFSA? Keep in mind that like an RRSP, a TFSA itself is not an investment. It’s a specially regulated container that holds investments. The name says “savings account,” but a TFSA isn’t limited to a bank account. You could have investments like mutual funds, guaranteed investment certificates (GICs), and, yes, a high-interest savings account inside your TFSA.
Here’s a small catch regarding the tax-free part: If you hold U.S. stocks in your TFSA, you’ll pay a 15% withholding tax on any dividends they earn. You won’t see this on your tax bill, though. That 15% is usually deducted at source, before you get your dividends. In effect, it lowers your dividend income by 15%.
“The tax advantages of a TFSA make it ideal as part of any savings and investment plan,” says Seibel. “Especially ones that are longer-term, so they have more time to accumulate tax-free returns.”
We’re here to help
If you have questions about saving and investing for retirement, we can help. Find out how a TFSA can be an important part of your retirement planning.
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A version of this article was originally published on December 30, 2021.