The TFSA: A flexible savings vehicle

The tax-free savings account (TFSA) is a flexible savings vehicle that adapts to different investment goals. How you use it depends on what you're saving for. Maybe you want to build a nest egg for your retirement, invest in your kids' education, set up an emergency fund, or contribute to your spouse's or your children's savings. Sébastien Lafontaine, financial planner and mutual fund advisor at FlexiFonds de solidarité FTQ, takes us through five scenarios.

01 Preparing for retirement

When it comes to saving for retirement, most people think of the registered retirement savings plan (RRSP), which offers the immediate benefit of tax-deductible contributions. But the TFSA can also be an important tool in planning your post–working life income.

If you expect to have less income in retirement, consider investing first in your RRSP and then in your TFSA.

"Depending on your investor profile, once you've maxed out your RRSP, you can maximize your retirement capital by investing more in your TFSA, which has strong long-term income potential," says Sébastien Lafontaine.

Your tax rate will be lower when you withdraw these amounts than when you contributed them, so you'll end up paying less tax.

If, on the other hand, your income is likely to go up in retirement, an RRSP could put you at a disadvantage tax-wise. Ultimately, the RRSP and TFSA are complementary retirement savings tools. These are key principles to consider to ensure your overall retirement plan meets your needs.

02 Investing in your children's RESPs

The registered education savings plan (RESP) allows you to save money for your kids' post-secondary education. Your contributions grow tax-free and are bolstered by federal and provincial grants. These government contributions add up to at least 30 percent on the first $2,500 invested each year for a child under the age of 18. The cumulative contribution maximum is $50,000 per child. For more modest family incomes, the grants may reach up to 45 percent for the first $500 contributed. In addition, low-income families automatically receive the $500 Canada Learning Bond when they open an RESP.

"Another advantage with RESPs is that withdrawals can begin as soon as your child has proof of post-secondary enrolment, and the money withdrawn is usually tax-free since students tend to have little income," says Lafontaine. "Your child can then put that money into their TFSA to keep generating non-taxable income that they can eventually put toward their studies. They can start making TFSA contributions once they turn 18."

Using this savings tool requires signing a contract with an RESP promoter. RESPs are registered with the Canada Revenue Agency and have a maximum lifespan of 35 years, with some exceptions. It's possible to designate more than one RESP beneficiary. The promoter is responsible for administering the amounts invested in the RESP and making payments to the beneficiaries to finance their post-secondary education.

If a beneficiary does not pursue post-secondary studies, the government grants must be repaid, and the promoter will return all contributions and earned income to the subscriber.

03 Creating an emergency fund

You can use a TFSA to establish a rainy day fund for contingencies such as a loss of employment or home or auto repairs. Here's why this savings vehicle is a wise option for building a financial cushion:

• The income generated on TFSA investments is non-taxable
• You can make tax-free withdrawals at any time
• It's easy to make contributions with automatic bank withdrawals

"As a general rule, it's recommended to set aside enough money to cover at least three months of expenses," says Lafontaine. "If you decide to use a TFSA to set up an emergency fund, you can opt for a reliable savings product such as a redeemable TFSA guaranteed investment certificate, which you can cash out at any time, or a TFSA savings account. Your savings will be sheltered from market fluctuations, which is important when you may need to access them on short notice."

04 Reinvesting mandatory RRIF withdrawals

You're required to convert your RRSP into a registered retirement income fund (RRIF) by the end of the year you turn 71, after which you must make a minimum withdrawal every year. "You may not need the money at that point because of other sources of income," says Lafontaine. "If so, a good strategy could be to take the amounts withdrawn, which are taxable, and invest as much as your contribution room allows in your TFSA so that they generate non-taxable income."

Of course, it's important to invest the money in your TFSA according to your risk tolerance and your investment horizon (the period of time over which you plan to leave the funds to grow).

05 Supplementing your family's savings

The TFSA is an individual account, but once you've used up your contribution room, you have the option of gifting funds to your spouse or your children (if they're 18 or older) for them to invest in their TFSAs. In this case, the gifted amount and the interest it earns will no longer be yours, but theirs.

"It's a way to increase your family's assets without incurring taxes," says Lafontaine. "However, married couples should be aware that TFSAs are not part of the family patrimony, unlike RRSPs. But depending on the couple's matrimonial regime, they could be part of each spouse's individual property in the event of divorce."

It's also important to remember that the total amount invested in your spouse's or your child's TFSA cannot exceed their total contribution room.

 
As you can see, the TFSA can be used in various ways, depending on your needs. The key is to make it work for you so you can maximize its tax benefits. A financial planner can help you do just that by evaluating your situation and objectives to develop the investment strategy that's right for you.