TFSA strategies

January 2009 saw the launch of the Tax Free Savings Account (TFSA). From an advisor’s point of view, the small initial contribution room mean TFSAs are more of a make work project. But as contribution room grows each year, advisors who incorporate TFSAs into their planning strategies will save clients a significant amount of money and will likely see their revenue per family rise. Here are a few TFSA planning strategies to consider:

1. TFSA vs. RRSP?

As a general rule if a client will be in a lower tax bracket post-retirement contributing to an RRSP is still the right option. Inversely if the client will be in a higher tax bracket post-retirement, they should own a TFSA. If the client’s tax bracket will be the same, the two options should provide the same result, in theory.

Where the “theory” becomes grey is when we factor in the clawback of retirement benefits such as the Guaranteed Income Supplement (GIS), the Age Credit, and Old Age Security (OAS). Income withdrawn from a TFSA will not impact these benefits. For clients in the same tax bracket before and after retirement, the potential to reduce clawback could give the edge to the TFSA.

2. Early RRSP withdrawals

The clawback issue, combined with the availability of a TFSA, means more people may benefit from making annual withdrawals from their RRSP and depositing the proceeds to their TFSA before age 65.

For example, a retired Ontario resident with a $30,000 pension could withdraw $5,000 annually from age 57 to age 64 and still be in the lowest marginal tax bracket. The proceeds could then be invested in her TFSA. At 65, more assets would be held outside her RRSP and withdrawals from her TFSA would not reduce the age tax credit. This could be a potential saving of hundreds of dollars annually.

3. TFSA vs. RRSP – Contribute to both

It makes sense for most clients to continue contributing to an RRSP, but why not also contribute to a TFSA? A client in a 40% tax bracket contributing $1,000 monthly to their RRSP will generate a refund of almost $5,000. That’s the perfect amount to deposit into a TFSA. Better yet, have the client reduce their taxes at source and contribute the tax savings monthly to their TFSA (Form T1213).

4. TFSA vs. Homebuyers’ Plan (HBP)

I’ve never been a fan of using the Home Buyer’s Plan (HBP) to purchase a house but I’m frequently asked if it makes sense. Do you know someone with a pension? Is that person allowed to take $20,000 from their pension and pay it back over 15 years? The answer is “no” and the reason is because pensions are meant for retirement and withdrawing funds prior to retirement means you’ll have to work longer before you can retire.

TFSAs are the best vehicle to save money for a house because the funds will grow and ultimately be withdrawn tax free and clients won’t have to touch their RRSP assets. The other added benefit is that TFSA withdrawals don’t have to be repaid over the next 15 years as they do with the HBP so the clients (usually young families) will have more cashflow to commit to insurance premiums to protect their family, income and lifestyle. The same arguments apply to Lifelong Learning Plan withdrawals.

5. Using a TFSA to complement an RESP

Unlike the HBP, I’ve always been a fan of RESPs because they involve what I like to call “free money” — the 20% government matching contribution on the first $2,500 of client contributions. However, the government caps the Canada Education Savings Grant at $7,200 and there is a lifetime maximum contribution limit of $50,000.

TFSAs are an additional vehicle to save funds once RESPs have been maximized. Parents can contribute funds to their own TFSAs and when their child turns 18 the funds can be given to and re-deposited in the child’s own TFSA, without any income attribution, until the funds are needed for school.

6. The gift that keeps on splitting

The absence of attribution rules and the fact that contribution room is not based on earned income means that TFSAs are a great way to split family assets. While there may be tax implications upon the sale of non-registered assets, assets held by the more heavily taxed spouse can now be sold and given to the spouse in a lower tax bracket. For example, a maturing $5,000 GIC owned by the high-tax spouse could be given to the low-tax spouse to be invested in the latter’s TFSA. Any future income and the eventual sale would not be attributed back to the high-tax spouse.

7. Double the contribution room

A client can contribute $5,000 to his or her own TFSA and can also give their spouse $5,000 to contribute to their TFSA. This has the effect of increasing the annual contribution limit for a family to $10,000 if two TFSAs are opened. Funds can also be given to an adult child to invest in their own TFSA without any attribution rules, but the child will legally own the assets, so beware of the legal implications.

8. Choose your assets wisely

TFSAs make deciding where to hold particular investments more complicated: RRSP vs. TFSA vs. open. This analysis ignores short-term investments and will not apply to every situation.

Investments generating interest income should first be held inside an RRSP. If additional room is needed, the overflow should be held inside a TFSA and the last place to hold these investments would be in an open account.

After an RRSP has been maximized and you are comparing investments generating dividend and capital gain income, holding dividend paying investments in a TFSA should be the priority. Not only can dividend income be more frequent than capital gains, the process of grossing up dividends held in an open account may reduce your eligibility for GIS, OAS and the age credit.

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Mathieu Paradis, B.Comm., CFP, CLU, FMA is co-founder of AdvisorPractice.com which offers advisors practical solutions to transition to a financial planning practice. He is also a financial planner offering his clients comprehensive life goals financial planning through the firm Wealth Strategies.

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Mathieu Paradis