The benefits of a tax free account

With the introduction of tax free savings accounts (TFSA), people have been wondering what sort of benefits they provide. So what are the main reasons to consider a TFSA?

The first reason would be to replace the interest exemption in our tax laws. It was specifically stated that with the introduction of the TFSA, there would be no increase to the annual interest exemption in future. Since many retirees used this interest exemption to minimise tax in retirement, a TFSA becomes the alternative.

The second major reason to use a TFSA is for the capital gains tax (CGT) exemption. This addresses the erosion of value every investor faces when they convert their growth asset to an income-producing asset.

For example, let us assume you have built a portfolio of high growth, low interest unit trusts. You reach retirement and now wish to restructure your investment to produce higher income, possibly by switching to high paying dividend funds and property funds. This switch would generally create a CGT liability and lead to an erosion of the absolute income that could be generated by the portfolio. Using this approach in a TFSA will certainly pay handsomely in the long term.

The third benefit of TFSAs is that they can create tax-free income. The way our tax legislation is written, income from different places combines to create an escalating tax liability. For example, someone may have a pension, rental income, interest from a bank deposit and some part time employment. Each of these may be under the threshold in their own right, but when combined they create a tax liability that reduces the individual’s disposable income. Consequently, any investment that can create a tax-free revenue stream has to be very attractive.

In conclusion, there are some scenarios where a TFSA would add value to your retirement and some where it would not. If you are still unsure whether it would benefit you or not then let’s get in touch, I can help you out!

Posted in Tax FAQ's.