Canadian TFSA Vs American Roth Ira

by Mike Holman

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This is part three of my three part series comparing various Canadian and American investment accounts.

I had a request recently from a blogger friend of mine – Paid Twice, who thought it would be a good idea to do a post on some of the more common U.S. and Canadian investment accounts. This post deals with the Canadian TFSA and the American Roth IRA. In part one I looked at retirement accounts – the Canadian RRSP and the American 401(k) . Part 2 compared educational savings plans – the Canadian RESP vs American 529 plan.

Please note that this is just a general comparison – it’s not intended to be reference material for any of the accounts listed.

A big thanks to Madison from My Dollar Plan for helping out with this series.

canada_flag.gif mini-americanflag.gif

Canadian savings account

TFSA – Tax-Free Savings Account

American equivalent

Roth IRA

Similarities

  • All contributions to these accounts are after-tax money. No tax benefit is generated from the contribution – however a contribution to the Roth IRA can qualify for the retirement savings credit.
  • All earnings of any type within the TFSA and Roth IRA are not taxed.
  • Most common security types (stocks, mutual funds etc) are allowed to be purchased in account.
  • Annual limits are similar – $5,000 for the TFSA in 2009 and $5,000 for the Roth ($6,000 if you are age 50 or older).
  • Relatively new account types. The Roth IRA was established in 1998 and the TFSA doesn’t start until January 1, 2009.

Differences

  • Withdrawals from the TFSA are not taxable. Withdrawals of contributions from a Roth IRA are not taxable but withdrawal of earnings are only not taxable if the participant is 59.5 years of age or older and the account has been opened for at least 5 years.
  • Contributions limits for the TFSA are not income dependent. Limits for the Roth IRA are phased out with higher incomes.
  • TFSA contribution room can be carried forward (accumulated) which is not the case for the Roth IRA.

Conclusion

The general idea of these accounts is quite similar in that you can contribute after-tax money and allow it to grow tax-free. The TFSA withdrawal rules are much more lenient than that of the Roth IRA but as discussed earlier in the series, this might not be such a good thing if it encourages investors to withdraw money without good reason.

Read more for a detailed look at the 2009 Roth IRA contribution limits.  That post also covers phase out and traditional IRA.

More information on the TFSA

Benefits of the Canadian tax free savings account

Tax Free Savings Account (TFSA) Basic information for Canadians

Tax Free Savings Account refresher for Canada

ING offers TFSA refresher for Canadians

Is the RRSP still worthwhile because of TFSA accounts?

Using the Tax Free Savings Account (TFSA) for Canadians as an emergency fund

More Information

Roth IRA Contribution Limits For 2010

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Want to learn more about RESPs? Buy The Book:

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The RESP Book: The Simple Guide to Registered Education Savings Plans

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{ 17 comments… read them below or add one }

1 Mr. Cheap

The TFSA is very interesting. I’m looking forward to seeing if its used at all (or if people don’t bother with it).

Both are definitely dangerous for the wrong person (who can’t keep their hands off their retirement savings).

2 Four Pillars

I think the TFSA will get used but the benefit is pretty small for most people since your average person would benefit more from using their rrsp.

I guess pretty much any kind of savings is “dangerous” since it can be spent. Even if you have more restrictions on an account type (ie 401k) then that will discourage people from making contributions (since they can’t get it out easily if necessary).

3 Mr. Cheap

Very true.

4 bigasssuperstar

I’m *so* looking forward to the TFSA, since my RRSP limit is so tiny due to pension adjustment.

Hey chief, once you’re done the series, I’d totally dig a handy table for easy translation when we’re reading cross-border articles…

Like, “when you see (Roth IRA), think (TFSA),” etc. … ‘cuz when I’m following ‘merican blogs & podcasts, I can’t keep 401k, IRA, etc. straight with their relative Canadian counterparts. I know the whole point is to point out the similarities and differences….

5 Shevy

You know, I’m not even thinking most people will use the TFSA as a retirement vehicle. It’s a way to keep a certain amount of money in a savings account and earn interest on it without having to pay taxes on the interest. Period.

You can access the money for whatever you want, whenever you want and it doesn’t have the strict repayment rules that you have to follow if you take money out of your RRSP to pay for a down payment on a place, or for educational purposes.

So, you could save money for a couple of years and then take it all out to pay for a trip to Europe, or take money out every few months for things like home renovations or new eyeglasses or to pay your property taxes. You don’t have to have the intention of saving for retirement.

6 Four Pillars

Hey BigAss – thanks for the suggestion. I think a quick summary comparison sheet was what PaidTwice (the blogger who suggested this) had in mind but of course I had to go and make a big series on it. :)

Shevy – you are correct. The TFSA can be used for retirement but also for many other things.

7 Gates VP

Hey I really like Shevy’s idea on the TFSA, especially for younger people. Saving for a down payment on a home could take a few years and simply saving the tax on the interest could be a good use.

If I save 20k over 4 years that’s a few hundred bucks in taxes saved (unless we keep getting 2% rates)

8 Squawkfox

I am very excited about the TFSA! I max out my RRSP every darn year…and still have some savings to boot. I do plan to use the TFSA in my retirement strategy. Unlike an RRSP, the money does not get taxed when taken out. Plus, 5K a year multiplied by 30 plus years is a nice tidy sum. :)

9 Assetologist

I still think that the TFSA is a great plan in which to swing for the fences.

If one has a few extra bucks and can afford to lose a little (limited to $5000/year) it makes sense to purse the highest Risk (& Reward) investments in a TFS Plan.

If you hit a home run or two, not only is the capital gain tax-free but any subsequent withdrawal will leave the equivalent contribution room.

The TFSA has many advantages and it will be a valuable tool to those Canadians who choose to use it.

10 fersure

Are there any discount brokers preparing for the TFSA? I know ING Canada is already collecting customer info in preparation of Jan.1 roll-over: however, I haven’t seen any other companies offering this service. Is it even worth their while until the minimum reaches $10,000?

11 Four Pillars

Assetologist – I disagree – the relative small size of the tfsa contribution room shouldn’t change your investment plan. It’s just another tool to use.

fersure – I would assume that all the discount brokerages are preparing for the TFSA although I haven’t heard anything official yet. It will be a loss leader but they have to have it.

Mike

12 Charles in Vancouver

I don’t remember where I saw the comparison but I believe that (unless you are confident about when your income level or tax rates will be higher or lower) for many investors TFSA and RRSP provide identical results. The difference is that to obtain those results…

With TFSA: Invest the after-tax money, period.
With RRSP: Invest the after-tax money, get a refund on your tax return, and invest that additional money too.

13 Steve L

This is AWESOME! The statement “All earnings of any type within the TFSA and Roth IRA are not taxed” brings a tear to my eye! I knew about this benefit in the american ROTH IRA, but now, for this benefit to be available in canada, with better terms.. WOW!
That means I can invest in a real estate transaction through my TFSA, cash out profit into the TFSA, then withdraw tax free, for anything.
Too good to be true. I must be missing something. Does the TFSA have a minimum investment amount like the ROTH’s $100 dollar amount? Who controls and issues the moneys?
Thanks,
Steve

14 TexaCan

Great post. As a Canadian who has been living & working in the US for 9+ years, I have often griped about the lack of Roth-like investment options in Canada. In the US, one has to choose between maintaining a _taxable_ cash “buffer” fund in addition to (or instead of) Roth account contributions. So, I see the flexibility of the TFSA as an improvement over the Roth (IRA & 401(k)) options available in the US. As I see it, the TFSA encourages investing for long-term growth not only by saving taxes on investment, but also by not penalizing early withdrawls to address short-term financial hardship without penalty. Way to go Canada! (FURTHER NOTE: One draw-back of moving back to Canada, is how Roth funds will be taxed. Up until now, there have been no “Roth-equivalent” accounts in Canada. So withdrawls from Roth accounts would be taxed as regular income. (This means a double-tax!) I hop that with the advent of the TFSA, there will now be some “equivalence” rules that will apply for returning Ex-Pats from the US who have Roth accounts. I shall wait and see.)

15 Fab

Hi,

Can a canadian perm. resident (living in Canada and using TFSA) and US citizen contribute to its Roth IRA ?

16 Elizabeth

Can American citizens invest in a Canadian TFSA account?

17 brian

I am moving back to Canada after years of working in the US and have money in a Roth IRA. When I finally withdraw the money after age 65 while living in Canada, how will I be taxed by the US and Canada governments? Thanks

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