Tax tips for TFSAs

FORUM Magazine

2009-01-19


10 ways to benefit from contributing

With the launch of the new tax-free savings account earlier this month, you’d be hard pressed to find a client who could not benefit in some way from contributing up to $5,000 to a TFSA in 2009. Here then is a list of my top- 10 TFSA opportunities:

1. Emergency funds

The TFSA, with its enormous flexibility, may be the ideal place to begin that proverbial “rainy day fund.” Such emergency funds are often parked in high-interest savings accounts, guaranteed investment certificates or money market funds.

The problem with such investments when held outside a registered account is that they generate interest income that is fully taxable at marginal tax rates. By holding such interest-paying investments in the TFSA, clients will be able to earn otherwise highly taxed interest income, completely tax-free for life.

In addition, the ability to recontribute any amount withdrawn from the TFSA beginning the year after withdrawal allows any funds accessed in an emergency to be repaid at any time in the future.

2. High-risk investment speculation

On the other side of the investment spectrum, the TFSA can also be the perfect place to hold equities and other riskier assets to generate unlimited tax-free returns. Imagine putting $5,000 into penny stock, perhaps purchasing 10,000 shares of that speculative junior mining-oil-gas-potash play into the TFSA and hitting a home run. The entire amount of the gain would be tax-free.

What if you lose it all? The downside is limited since all you’ve really lost (besides the value of your investment, of course) is the ability to claim, at least initially, a $5,000 capital loss, which is worth a maximum of 24 per cent, depending on your province of residence.

3. Collateralized lending

Unlike an RRSP or RRIF, you may be able to pledge your TFSA assets as collateral for a loan or a secured line of credit, thus perhaps getting a lower interest rate than an unsecured line. Clearly this will be of greater advantage as the TFSA balance builds up over future years.

4. Protecting government benefits

For Canadians with low and modest incomes, the TFSA can help preserve certain income-tested government benefits since TFSA withdrawals are not considered to be income. For a young person receiving the GST credit or the Child Tax Benefit or a senior living on the Guaranteed Income Supplement (GIS) or the Old Age Security (OAS), the ability to protect these benefits even when funds are withdrawn from a TFSA is a major victory of sorts.

5. Tax rate planning

For Canadians with limited funds who are currently in a low tax bracket but who expect to be in a higher tax bracket upon retirement, contributing to a TFSA may be preferred to making an RRSP contribution. Ultimately, as you get into a higher tax bracket before retirement, the TFSA money can be moved into an RRSP, tax-free, restoring TFSA contribution room beginning the following year.

6. Retirement planning

Taxpayers who can’t contribute to an RRSP (for example, someone over age 71, or with no earned income, or with a large pension adjustment) can use the TFSA to invest for their retirement on a completely tax-free basis and with no forced minimum withdrawal — ever!

7. Education planning

While RESPs are expected to remain the vehicle of choice primarily because of the federal (and in some cases, provincial) grants, for savings beyond the level needed to maximize the grants, TFSAs offer another flexible alternative. Plus, TFSA money can also be used to save for private school education since RESP monies can only be used to fund post-secondary schooling.

8. Income splitting with a spouse and kids (over 18)

If you’ve got a spouse or partner, you are permitted to give him or her funds to open up their own TFSA without having the normal attribution rules for income and capital gains apply. Similarly, you can give each child over 18 money to open up his or her own TFSA, with no attribution consequences. Note that you cannot open an “in-trust for” TFSA.

9. Estate planning

The entire TFSA will be tax-free upon death. The TFSA monies can be rolled over to a surviving spouse or partner’s TFSA after death to maintain the tax-free status of the account. If left to anyone else, future income and gains will be taxable.

Look for the ability to name a beneficiary on a TFSA in 2009 in many provinces. At the time of writing, only Nova Scotia has introduced legislation to permit this. Once passed into law, this would allow for TFSA monies to pass directly to a named beneficiary, bypassing the estate and savings probate taxes, where applicable.

10. Emigration (non-resident) planning

Finally, clients wishing to emigrate from Canada can still hold a TFSA tax-free for the rest of their lives and pay no Canadian tax on continued TFSA growth. No future contributions would be permitted as a non-resident without having to pay a penalty tax. Of course, the other country will likely tax the earnings and growth in the TFSA annually.