You may already be aware of the benefits of a Tax-Free Savings Account (TFSA) for your personal finances, but you can put a TFSA to work for your business too.
What is a TFSA?
Tax-Free Savings Accounts were introduced in 2009 as an easy, flexible way for Canadians to save, regardless of their stage in life or income level. With a TFSA, you pay no tax on interest income, capital gains or withdrawals, and your contribution room is restored if you make a withdrawal.
TFSAs for small business owners
You can’t open a TFSA under your business name, but you can fund your TFSA with your business earnings and build your savings to:
• Build capital. Whether you want to start a new business or build a business emergency fund, you can save faster and have quick access to cash when you need it.
• Boost your retirement savings. You may be used to putting everything into your business, but will you get enough out of it to retire? Include investing in a TFSA as part of your retirement plan to maximize your savings.
• Help your employees buy shares. If you own a publicly-traded company, you can set up a TFSA as part of an employee share purchase plan. Employees usually hold shares in non-registered investments or group RSPs, but if employee shares are held in a TFSA, dividends, capital gains or withdrawals are not taxed. You can hold corporate shares in your corporation in your TFSA if:
o You and your partners own less than 10% of a Canadian-controlled corporation;
o Most of the fair market value of the corporation’s assets are used in an active business based mainly in Canada; and
o Shares or debt are connected to the corporation.
As with an individual TFSA, the dividends and capital gains earned within your corporate TFSA would be tax exempt, and you would not pay tax on withdrawal.
Top benefits of a TFSA
Whether you have a TFSA for your personal finances, your business earnings or both, there are many advantages to this popular savings plan.
No tax on earnings or withdrawals. You already paid income tax when you earned the money you contribute to a TFSA, so you don’t pay tax on TFSA savings when you withdraw the money. You also don’t pay tax on the interest you earn within the TFSA, so your earnings grow faster.
Flexibility. You can access your TFSA savings whenever you choose, which makes a TFSA ideal for both short and long-term savings goals.
Unlimited carry-forward of contribution room. Since the plan started in 2009, each Canadian over the
age of 18 has earned contribution room each year starting at $5,000 for the first four years, $5,500 per year for 2013 and 2014, and now $10,000 starting in 2015. So if you’ve never had a TFSA, as of this year you could contribute up to $41,000, which you can do at any time.
Keep your contribution room: You don’t lose your contribution room on withdrawals. It gets added to your unused contribution room for future years.
Benefits for spouses. You cannot contribute directly to your spouse’s TFSA, but you can split your income by giving your spouse or other family members money to contribute to their own TFSAs. The money they earn within their TFSA is not taxed.
Maintain access to government benefits and credits. Your TFSA savings and earnings aren’t considered when you apply for government programs such as Old Age Security, GST/HST tax credit, employment insurance, and others. In some cases, you can also use your TFSA as loan collateral.
Simple transfer to your spouse. When you pass away, you can have your TFSA transferred to your spouse without affecting their contribution room.
Keep saving past retirement. You can continue to contribute to your TFSA even after you have to stop RRSP contributions at age 71.
TFSA or RRSP? How to choose.
Both programs offer excellent tax advantages and savings potential, so it’s most beneficial to maximize your savings to both. If you have to choose one over the other, get to know the differences before you decide.
With an RRSP, you can deduct the contribution from your income, which earns you a tax refund. However, the money invested and its earnings become fully taxable when you take it out. The TFSA is the reverse; you don’t get a tax deduction when you contribute, but you also don’t pay tax on the withdrawals. Both investments serve as a tax shelter, because you don’t pay taxes on them while the investments grow. The ultimate question comes down to whether you want to pay taxes now (no deduction with contribution) or pay later (taxable upon withdrawal).
Your tax rate should help you determine which option is best. If you are currently in a higher tax bracket than you expect to be when you withdraw the funds, then it is better to invest in a RRSP. Your original contribution will give you a substantial tax rebate now, and there will be less tax to pay on withdrawal when you are in the lower bracket. If you plan to take the money out soon, while you are still in a high or even higher tax bracket, then you should choose a TFSA.
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