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Ah, Budget Day! One of the few days in the year when the finance minister gets a new pair of shoes, accountants in Ottawa suddenly feel like movie stars, and the CBC has so much Class A news content to share that they nearly collapse from the pressure in the newsroom. Yesterday, the federal government announced a new tax-savings vehicle for Canadians designed to help people save money on taxes. But what are the true savings versus an HSA?
Tax-Free Savings Account. This flexible, registered, general-purpose account is designed to allow Canadians to save money, tax-free. Starting in 2009, Canadians can contribute up to $5,000 every year to a registered Tax-Free Savings Account, plus carry forward any unused room to future years. The investment income, including capital gains, earned in the plan will be exempt from any tax, even when withdrawn. Canadians can withdraw from the account at any time without restriction. There are no restrictions on what they can save for; and the full amount of withdrawals may be re-contributed to their Tax-Free Savings Account in the future, to ensure no loss in a person’s total savings room.
It is important to note here that the $5,000 is not a deduction. It is an allowance. This means that you will not have to pay any tax on the interest this $5,000 earns. So what are the savings? Well, let’s say you are an incorporated professional in the $100,000 income tax bracket and you deposit $5,000 into a TFSA. You then use these funds to invest and your rate of return is 4%. Well, you would be looking at a total annual tax savings of $27.00 versus a traditional taxable account.
Health Spending Account. Now let’s take the same $5,000 and have your incorporated entity deposit the funds into an HSA in the form of a Health and Welfare Trust. The $5,000 becomes a business deduction for the company and is a non-taxable benefit for you, the employee. In essence, you are receiving $5,000 tax-free to pay for your current after-tax healthcare expenses. If these expenses are already $5,000 per year, you just saved yourself roughly $2,029.00 in taxes in comparison to the current medical tax credit less related fees for administering the HSA.
Both a Health and Welfare Trust and the new Tax-Free Savings Account can be used as a savings vehicle for future spending. While the HWT does not earn interest, the initial tax savings far exceeds any reasonable return one could hope for from an investment using a TFSA. But a TFSA does sound like a great tool for short-term savings. The question is, which is a better strategy. Opening a TFSA on January 1st, 2009 and depositing $5,000 or opening an HWT for the same amount and taking the $2,029.00 in tax savings to fund a TFSA the following year? Sounds complex, but a better model for making your money work for you in my opinion.
It is the last week for Canadians to make contributions into their RRSP to take advantage of the tax-deduction for 2007. I myself have received numerous calls from my financial advisor reminding me to top-up my contributions for 2007 and letters indicating that my advisors will be available until the wee hours of the night to help me should I decide to add more to my investment plan. It makes me wonder, how many Canadian small business owners would put more into the RRSP each year if they could free up the extra money? Are they spent?
Financial advisors tend to focus on the after-tax money available to invest as opposed to looking at ways to free-up pre-tax dollars as a tool for investing. For many small business owners, the HSA is an unknown option. Each year, they take a few of their after-tax receipts and make a claim for the medical tax credit. A nice gesture from the federal government to reimburse for medical expenses but certainly not enough to give someone more money to invest. The reality is that if they had a Health Spending Account, they could be using the tax-savings to re-invest into their retirement plan.
Each year, some financial advisors look for ways their small business clients can contribute more without giving them any real options to free-up the funds to do it. To all my readers out there who are financial advisors with small business clients…get them an HSA today! Show them how they can make their current after-tax expenses into pre-tax business deductions. Show them how this will impact their taxable earnings and how they can use the savings to re-invest in their RRSP! Given the economic conditions and the tough time your clients have had this year, this is a great way to show them how resourceful you are in finding ways to build wealth for them using a readily available and sensible solution – the HSA.
