Who will use Tax Free Savings Accounts?

The government introduced Tax Free Savings Accounts (TFSAs) in the 2008 Federal Budget but will Canadians use these accounts? Will people be encouraged to save more money with the introduction of TFSAs? All I know for sure is I plan to maximize my $5000 contribution in 2009.

Unfortunately, statistics show people are not saving money and I'm not sure TFSAs have enough immediate benefit to change peoples savings habits. That being said, TFSAs create a lot of new opportunities for Canadians to save money so to encourage and foster more savings from Canadians, here are a few ways some people might use TFSAs in the future.

Saving to spend. According to Financial Counselor Tricia French, TFSAs will make great accounts for not just long-term savings but also for short term spending. "I've seen too many people put a few dollars into a RRSP and then take it out after a few months. This behavior goes against how RRSPs should be used as it destroys people's RRSP contribution room. TFSAs might be the best way to start a savings plan. At the end of the year, if they want the RRSP deduction, they can move it from the TFSA. TFSAs offer more flexibility when it comes to savings."

Conservative savers. Savers will love having the TFSA especially savers who already maximize their RRSP and currently save in non-registered accounts. TFSAs have a clear advantage over non-RRSP savings for Canadians young or old. Savers in retirement will also benefit because they can still use TFSAs after the age of 71. Young savers will benefit from the magic of compound interest over the long term. TFSAs will especially benefit the ultra conservative investors who like Guaranteed investments. Now holding GICs, Bonds, money markets and savings accounts inside a TFSA makes a lot of sense because you no longer have to pay tax on the interest. The TFSA is the great investment equalizer because you don't get punished from a tax perspective by being conservative.

People with Strong pension plans. Employees who belong to pension plans can find themselves with very little RRSP contribution room leaving them with little opportunity for long term tax sheltered savings. TFSAs will give these employees another tax-sheltered vehicle for saving money.

Retirees avoiding clawbacks. With respect to dividend income, although the dividend tax credit makes dividend income the most tax-preferred source of investment income, the dividend gross up has the potential to create problems when it comes to income tested programs and clawbacks. Now, holding investments that created dividend income inside a TFSA might help people avoid clawbacks on Old Age Security (OAS) and the Guaranteed Income Supplement (GIS).

Interesting benefits for estate planning. Sometimes significant non-RRSP accounts can trigger significant tax bills based on unrealized capital gains and other forms of investment income. Moving money from non-RRSP accounts to TFSA may help prevent big tax surprises at death.

Financial Winfalls. In the future when TFSA plans have been around for a while and people build up their contribution limits, we may see some applications where people who get significant financial windfalls like an inheritance for example put significant amounts of money into TFSAs if they have the contribution room. If you do not contribute to a TFSA, you can carry forward the unused contribution room (much like an RRSP).

These ideas are just a few examples of how TFSAs might be used. This list is far from exhaustive since the opportunities for TFSAs are endless. It think French says it best "I can't imagine very many who couldn't find a use for it or benefit from it. I think this can be a benefit to anyone who wants to save and all they need is a little "tax-free" incentive. If anything I know I will benefit."