TFSA – Is Your Tax-Free Savings Account Fully Funded?

Should It Be?

May 3, 2018

Tax- Free Savings Accounts can be an excellent way to save money. With no tax consequences and potential for tax sheltered growth, the TFSA can be a great investment solution for many. However, is it worthwhile to make full contributions each year or should those funds be invested elsewhere? Here are some questions to consider:

1. Are you carrying debt?

The type of investments you hold within the TFSA, and particularly your rate of return, should be a consideration as to whether it is your best bet for sustainable growth. If you have debts with interest rates higher than your projected returns, it would make sense to pay off those liabilities before fully funding the TFSA. With interest rates rising on mortgages, you should also keep in mind what rate you may be looking at upon renewal. Even if your renewal is a few years down the road, planning for the future will ensure you have enough flexibility to pay off your debts, without having to withdraw from the TFSA and affecting your contribution room.

2. Do you owe taxes every year?

As discussed, there is no tax withheld when withdrawing from the TFSA. On the other hand, there are also no tax credits for contributing. If you owe income tax annually, an RRSP could give you an opportunity to reduce your overall tax liability. TFSA’s also use your after tax amount which, based on your marginal rate, may not make sense in the long term. Jamie Golombek, a Managing Director of Tax and Estate Planning for CIBC, discusses the role of RRSPs in funding retirement and compares how your contributions actually break down in terms of growth. According to his research, the potential returns on an RRSP can be more favourable than a TFSA in some cases.

3. Are there other investment options based on your goal?

If you are using the funds in the TFSA for a specific purpose, such as your children’s education, it may be more sensible to invest in an RESP which has beneficial tax treatment and government grants. Savings with a shorter time horizon, such as for a small vacation or a large future purchase, may be better allocated to a high- interest savings account or a short-term GIC. Determining the ultimate goal for your funds will ensure you are making the best decision when investing.

4. Will you need the funds in the foreseeable future?

TFSAs, while accessible, should be seen as long-term investments. Short-term savings goals will affect how you choose to invest your funds, and with the ability to grow your initial investment tax-free, the TFSA shouldn’t be the account for spending money. Pairing the TFSA with your RRSP for retirement savings, for example, allows for preferential taxation down the line. When you are making withdrawals in retirement, it is important to take into account your marginal tax rate. Doing so ensures more of the money you have scrimped and saved over the years actually goes to you. If you have a sizeable RRSP that you begin to drain when you first retire ,you may be setting yourself up for a large tax bill initially. An RRSP and a TFSA paired together can help you make the most of retirement savings and can ensure that your golden years are spent enjoying life, not worrying about funding it.