You may have heard of a TFSA, or a Tax Free Savings Account. This is a relatively new tool in helping Canadians save money, it was just created in 2009.
The first thing to know is that it has a horrible name. It’s not a savings account like you have at a bank. It’s similar to an RRSP where it’s not actually a product that you buy. Think of a TFSA as a folder where you can put in many different types of investments. You could put in cash and treat it like a regular savings account, but most people put in Stocks, Bonds or GICs. Keep this in mind, you don’t invest in a TFSA, you invest in other things that go into a TFSA which will allow it to grow tax free.
This is the second thing to know about a TFSA: you will not be taxed on any gains that your investments make when it’s inside your TFSA. This is a big deal which can lead to substantial savings over a regular investment.
Let’s say that you invested $5000 in a stock, you sell it when it’s worth $6000. You would have to pay tax on the $1000 of profit you made. If the stock was inside your TFSA, you would not have to pay the tax on the $1000.
The third thing you should know is that the money (or stocks, or bonds) that you put into the TFSA is done with money you have already been taxed on. This is the opposite from an RRSP, where you can contribute your pre-tax income into it. Let’s compare:
You earn $50,000 in a year. You contribute $10,000 to your RRSP. When you pay your income tax, to the government it appears you’ve earned $40,000, so that’s what you pay tax on. This could put you in a lower tax bracket so you pay less tax to the government. The money grows tax free while it’s in your RRSP, but when you want to take out the money you pay tax on it then. The idea is that when you’re retired, your income will be very low, so you’ll likely be in a low tax bracket when the money is taken out.
Now an example of a TFSA:
You earn $50,000 in a year. You invest $5,000 in a stock which is placed in your TFSA. At tax time, the government taxes you on the $50,000 you earned. The stock in your TFSA grows and eventually is worth $10,000. You eventually cash out the stock and pay no tax on it.
We always have to pay tax on the money we earn, it’s just a matter of when. For an RRSP, we pay it when we withdraw the money when we retire, for the TFSA we pay tax on it up front.
We have limits on how much we can put in our RRSPs and our TFAs. When TSFAs were introduced in 2009, the limit was $5000 per year. This amount carries over year after year if you don’t contribute. In 2013, the limit was raised to $5,500. This means at the time of this writing you can contribute up to $31,000 into a TSFA.
You may be wondering if you should put money into your RRSP or a TSFA. I think most VFX artists should try to put as much as they can into their RRSP, and use their TSFA as the place where they save for their emergency funds and for larger purchases.
The assumption I’m making is that most VFX artists will have no access to a pension, and will have almost zero income when they retire. This means that when you take out your RRSPs, you’ll be in a very low tax bracket. That’s the ideal situation when you’re taking out your RRSPs, that way you get the immediate tax benefit when you save your pre-tax income and you’ll pay (relatively) low tax on it when you withdraw it. Also, the heavy taxes you’ll pay on it if you withdraw it early will discourage you from wasting it on anything frivolous.
Where RRSPs can be tricky is if your spouse has access to a great pension, so if your partner is a teacher, policeman, doctor, nurse, government worker or public worker. In that case you might have a decent income when you’re retired, so the taxes on your RRSP might be pretty high. In this case, it might be wise to look at maximizing your TSFAs as you get into your forties and fifties.
The Globe and Mail had a nice article about the differences between TFSAs and RRSPs.
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