How do Tax-Free Savings Accounts fit with life insurance?

Like many Canadians, you may be wondering how to take advantage of the new Tax-Free Savings Account (TFSA). What place should it have in your financial security plan?

When used properly, the TFSA can allow you to grow and later access your savings tax-free, within the limits set out by the Canada Revenue Agency. This flexibility will surely change the way Canadians invest and save their money.

While it may be tempting to jump right in and take maximum advantage of the TFSA, don’t sacrifice your life insurance to do so. Life insurance is a vital cornerstone of a solid financial security plan. It helps you prepare for the uncontrollable events in life, which could otherwise derail your carefully thought-out investment strategy.

How to use each vehicle for maximum advantage

For many Canadians, the choice isn’t either/ or. It’s how to make best use of each option within your overall financial security plan.

• Think about how much protection you need. If your family needs $500,000 to replace lost income and pay debts, a $5,000 per year TFSA falls far short. Life insurance exponentially leverages your premium payments to create an instant, tax-free estate. It pays the full death benefit, even if the insured person dies the very first day the policy is in effect.
• Use life insurance first, to give your family a foundation of financial security.
• Then consider adding a TFSA to grow your savings on a tax-advantaged basis.

Talk with your financial security advisor about creating a plan to maximize the value of each option.

The information provided is based on current tax legislation and interpretations for Canadian residents and is accurate to the best of our knowledge as of the date of publication. Future changes to tax legislation and interpretations may affect this information. This information is general in nature, and is not intended to be legal or tax advice. For specific situations, you should consult the appropriate legal, accounting or tax advisor.

TFSA or RRSP: which comes first?

The new tax-free savings account (TFSA) is a flexible investment savings vehicle that allows you to earn investment income (including capital gains) tax-free.

Deciding whether you should contribute first to a TFSA or a registered retirement savings plan (RRSP), depends on your needs, and your current and future income tax rate.

Scenario one: Your tax rate when you redeem is the same as when you contribute
If you expect your income tax rate to be the same when you take the money out of either your TFSA or RRSP, as it was when you put the money in (meaning you expect your taxable income to be relatively the same), the value of a TFSA is the same as in an RRSP. This means you can choose to invest in either one.

However, your contribution limits may affect which type of savings vehicle you choose. At $5,000 per year, the TFSA limits are relatively low, so if you have more than $5,000 to invest, you could choose to start investing with a TFSA contribution, then, contribute the rest to an RRSP. A TFSA also makes sense if you don’t have any RRSP contribution room (for example due to a pension adjustment or being over 71 years-of-age).

Scenario two: You expect your tax rate when you redeem to be lower than today
If you expect your income tax rate to be lower when you take the money out of either your TFSA or RRSP (for example, during retirement) than when you put the money in, you can expect to benefit more from an RRSP. Consider using your RRSP contribution room first, then, contribute to a TFSA. You’ll obtain greater tax savings if you contribute a large amount to your RRSP now, when your income is greater and you’re subject to a higher tax rate.

Scenario three: You expect your tax rate when you redeem to be higher than today
If you expect your income tax rate to be higher when you take the money out of either your TFSA or RRSP (for example, during retirement) than when you put the money in, you can expect to benefit more from an TFSA. If you expect to earn a higher income in the future than you do now, it makes sense to contribute to a TFSA now (when you’re making less money and therefore paying less income tax), and contribute to your RRSP later (when you’ll be making more money and therefore subject to a higher tax rate, and your RRSP contribution will generate a larger deduction).

Other considerations
If you’re planning to use the funds for more short-term spending, versus long-term savings, you might also find a TFSA preferable.

Contact your financial security and investment representative today to determine which savings plan fits best with your financial security plan.

The information provided is based on current laws, regulations and other rules applicable to Canadian residents. It is accurate to the best of the writer’s knowledge as of the date of publication. Rules and their interpretation may change, affecting the accuracy of the information. The information provided is general in nature, and should not be relied upon as a substitute for advice in any specific situation. For specific situations, advice should be obtained from the appropriate professional advisors.