Posted on November 11, 2008 22:09 by
Sam Li
How it works
TFSA works similar to RRSP with a few differences but the idea behind it basically the same to help people save for retirement. I summarized it in a table below and I believe there is a possibility to built quite powerful strategy for financial independence during retirement years.
Here are differences
| RRSP |
TFSA |
Contributions up to 18% of previous year's earned income
|
Contributions up to $5,000.00 a year
|
Tax deductible contributions resulting in income tax refund
|
Contributions are not tax deductible |
| Savings grow tax deferred inside plan |
Saving grow tax free inside account
|
| Savings taxed when withdrawn |
Tax free withdrawals at any time with no tax payable on interest, capital gains or dividends accumulated on the original savings.
|
| $20,000 can be temporarily withdrawn for education or home ownership (amount treated as income if not repaid). Once withdrawn, the contribution room is lost |
Withdrawals do not reduce contribution room - they are added to unused contribution room |
To me it's clear that if you contribute to RRSP it will grow faster than TFSA but the problem is that you will need to pay taxes on these funds when you withdraw them during retirement and you never know what taxes will be in 20 years so it sort of gambling. I believe we can leverage the combination of RRSP and TFSA for our good and here is how.
Strategy
TFSA is not a replacement for RRSP, it's a complimentary tool. Think about it - what if we will blend them together. Let's play a scenario. John Doe is 40 years old currently earns $97,300 which entitles him to a contribution of about $17,500 , but he can only manage about $12,500 each year. Let's see what's going to happen to him in 20 years.
| |
RRSP |
TFSA |
|
| RRSP Contribution |
$12,500 |
|
Income tax refund of $5,000 , so far out of pocket spending is $7,500 ($12,500-$5,000) |
| Deposit to TFSA tax refund |
|
$5,000 |
|
| Assume 6% return rate for 20 years |
$527,498 |
$210,999 |
Funds available at age 60 |
If John will be able to get 6% on both accounts when he retires, his income
will be -> |
$31,650
Taxable |
$12,660
Non taxable |
|
Not bad at all, especially taking on account taxation aspect of the situation.
Here is a link to federal website - http://www.budget.gc.ca/2008/pamphlet-depliant/pamphlet-depliant2-eng.asp
How you leverage TFSA to retire earlier?