Recent Changes to TFSA Contribution Limits
The Financialist • Issue 128 • January 2016
BY SHAUN SUN BComm CFP
The announcement in December by the new Liberal government to act on their election campaign promise to reduce the annual maximum TFSA contribution limit for 2016 back down to $5,500 from the $10,000 granted by the exiting Conservatives in 2015 probably did not come as much of a surprise to many. The same can also be said about their decision to allow Canadians to keep the $10,000 contribution limit for 2015, regardless of whether or not they had taken advantage of the full amount before year-end. This brings the current cumulative maximum to date to $46,500. While there may have been some pre-election debate over which Canadians benefit more from higher TFSA limits, it is important to remember that TFSAs are by no means savings tools that only benefit “wealthy” Canadians. Let’s look at a case study:
Meet Sarah and James who are a newlywed couple, both age 28. Sarah just finished her full-time schooling in December last year to qualify as a teacher, but finding a full-time position has been extremely challenging. She has done reasonably well keeping herself busy by substituting for other teachers on leave, but she worries that the $30,000 she can expect to make this year based on the current availability of work may not materialize and will continue to vary year-to-year until she can find full-time employment. James has been a self-employed wedding videographer for the last 3 years, and while he expects business to continue to be good enough to allow him to make the same $50,000 he made last year, the seasonal nature of his contract work means that cashflow fluctuates drastically throughout the year. Sarah and James would like to have a child this year or next, and start saving now to put a down payment on a condo in the next 5 years, while also putting something aside for retirement. Neither has ever made contributions to a TFSA or RRSP, and they have some cash savings in a joint bank account. How should they go about saving for these goals?
For Sarah and James, the key to effective saving for their goals can be summarized in one word: flexibility. With the income uncertainty of Sarah’s substitute work and the added cashflow challenge of James’ business, contributing to TFSAs initially will allow them to build up savings in a tax-free environment and give them the potential to access these funds without tax implications while they adjust to the higher expenses of starting a family. Unlike RRSPs, which require that withdrawals be included in taxable income during the year they are taken, TFSA withdrawals do not. In addition, if Sarah was able to secure full-time work or James had excess cashflow, they could add back any withdrawals the following calendar year.
In Sarah and James’ case, there is also the consideration of total contribution room when comparing RRSPs versus TFSAs. RRSPs generate contribution room calculated as the lower of 18% of the previous year’s ‘earned income’ (which Sarah may not have much of as a substitute teacher) or the maximum annual contribution limit for the year ($24,930 for 2015, $25,370 for 2016), while TFSA contribution room is automatically given to individuals 18 years or older who have a valid SIN number. That means that both Sarah and James could each put $46,500 into a TFSA today. If the cash in the joint bank account has been earmarked for emergency savings, they may want to consider moving all or part of this into a high-interest savings account within the TFSA (see my article on Building an Efficient and Effective Emergency Fund in the July 2014 Financialist
). The money for the condo could be invested within the TFSAs in something low-to medium-risk depending on their risk tolerances. If they do have the ability to save something for retirement over and above building up their emergency savings and the condo down payment, then it would be best to consider diverting some of their savings towards RRSPs, where contributions will help to decrease their taxable income and overall tax bill. Sarah and James’ case is a reminder that TFSAs are a valuable tool that can be used by all Canadians – even those at the early stages of their financial life cycle. Ask your advisor at Rogers Group Financial how a TFSA may fit as part of your unique financial plan.