We’ve all heard of tax deductible Registered Retirement Savings Plans (RRSPs), but chances are you’re not yet earning enough to benefit from making a contribution.
That’s why the newly-launched Tax-Free Savings Account (TFSA) is so attractive. As long as you are 18 or 19 years old (depending on your province) and have a social insurance number you can open a TFSA and, “potentially, will never have to pay any investment income tax (on the TFSA earnings) ever in this country,” says Tina Di Vito, director of retirement strategies for BMO Financial Group.
Sound too good to be true?
“Essentially, 18 to 20-year-olds can pretty much be guaranteed, as long as they don’t change or eliminate the account, that they will never have to pay tax on any investment earnings. It’s amazing. You have to take advantage of it right now,” says Di Vito
Upon opening a TFSA you are allowed to contribute up to $5,000 per year, but “the average Canadian does not even save $5,000 per year,” Di Vito says.
Lucky for you, the amount is cumulative, so over a five year period, you can contribute a total of $25,000 without having to pay tax on any earnings. And whatever interest you make, you keep, even when you withdraw.“The TFSA clearly is the only account that you can actually make contributions to earn any kind of investment income and never have to pay tax on it either while it’s in the plan or when you pull it out,” Di Vito says.
It’s all about flexibility, says Patricia Lovett-Reid, senior vice president for TD Waterhouse, which is great, especially for students. It’s hard to put money away and have enough remaining for day-to-day living, Lovett-Reid explains. And, when something comes up and you need that extra cash, it’s always attainable.
“Students are often unsure as to what they are going to use that money for and when they are going to need it,” Lovett-Reid says. “Having access to ready cash is a premium for them and the TFSAs make sense for that.”
There are three key differences between a TFSA and an RRSP, explains Di Vito. Firstly, you don’t need to have an income to make a contribution to the TFSA, whereas you do need to have an income to contribute to an RRSP. Secondly, when you pull money out of a TFSA you don’t get taxed, but when you pull money out of an RRSP you do. And thirdly, when you contribute to a TFSA you don’t get any tax deduction or tax benefit, as you do when you contribute to an RRSP. “So, anyone who’s got low income, including college and university students, could actually benefit more from a TFSA because you get your $5,000 per year contribution regardless. Whereas, if you’re not working you wouldn’t be able to make your RRSP contribution,” Di Vito says. “I would absolutely recommend a TFSA over an RRSP until your income is higher and you can benefit from the tax deduction.”
“For students, these TFSAs are a great vehicle in terms of putting money away beyond what they are allowed to contribute to their RRSP,” agrees Andrew Pyle, a wealth advisor with ScotiaMcLeod, an arm of Scotia Capital, a company with the Scotiabank group.
Keep in mind that the TFSA is an investment account, just the same as an RRSP. That means you can risk more or less on your investments depending on your tolerance.
“Are you the kind of individual who will stay up all night worrying about investments or can you handle risk?,” asks Pyle. “Students have a long term goal if they are looking at these accounts as retirement vehicles. We would think those students could take a little more risk.”
That said, Pyle admits some students want to hang on to their hard earned cash and can be just as risk averse as 80 year-olds when it comes to investing in this economy’s stock market. “I’m seeing a lot more students coming out of school now with a much more serious view towards savings…and that’s great,” he goes on. “So, even if you’re only contributing $500 per year and investing it in something really safe, like a guaranteed investment certificate, it’s still $500 that’s going to earn interest tax-free, which is better than nothing. It buys you a Starbucks coffee to study over at the end of the day,” he laughs.
Hmm, TFSA equals more Starbucks. Yum. jp