TFSA vs. RRSP

Only two things are certain: death and taxes.

That is, until the Tax Free Savings Account (TFSA) in Canada! The TFSA is one of the most ingenious tax loopholes created in recent memory to encourage Canadians to save, not to mention the significant estate and financial planning benefits.

TFSASo, when bank sponsored TV commercials say they are “selling a TFSA for 2%,” what do they mean? Honestly, it’s a bit misleading since you can invest funds in your TFSA in a myriad of options, including stocks and bonds, and not just bank issued guaranteed investment certificates (GICs).

Below are a list of strategies to use this vehicle to your advantage and a comparison between TFSA and Registered Retirement Savings Plans (RRSP):

Tax:

  • Contributions to a TFSA are not tax deductible.
  • All eligible investment income – including capital gains, dividends, interest, etc. – are not taxed on the investments made in a TFSA, even when you withdraw the funds.
  • Foreign investments are not tax-sheltered since other countries, including the United States, do not recognize TFSA, so it is punitive to hold U.S. securities in your TFSA and be taxed on your foreign income.

Contributions:

  • You can find your TFSA contribution room/limit on your last tax year’s Notice of Assessment or by logging onto your My Service Canada account.
  • Unused TFSA contribution room can be carried forward indefinitely into future years.
  • Canadians ages 18 and older were able to contribute up to $5000 a year beginning in 2009. In 2012, that amount increased to $5500, and in 2015, the total contribution was raised to $10,000 per year.
  • You may contribute eligible securities to your TFSA at prevailing market prices.
  • Excess contributions above your limit will be charged a penalty of 1% per month that the funds remain in the TFSA. (OUCH, that’s 12% per year!)

Eligible Investments:

  • You can invest the funds contributed into your TFSA in many different investment vehicles including listed public stocks, bonds and many other investments.
  • You cannot hold your mortgage in your TFSA.
  • Income from non-qualified investments or from a business carried on by a TFSA is deemed to be taxable by CRA. ‘Day trading‘ within your TFSA may be considered as business activity and as such, may attract income tax on income and gains related directly or indirectly from that activity.

Withdrawals/Transactions:

  • You can withdraw from your TFSA at any time for any purpose.
  • Withdrawals are not taxable and do not affect any other pension or Government benefits.
  • Funds that you withdraw from your TFSA can be re-contributed into your TFSA in the following or subsequent calendar years but cannot be re-contributed into your TFSA in the same calendar year that it was withdrawn.
  • For example, if you deposit $5000 in 2013, you withdraw the proceeds of $6500 later in 2014, you may deposit up to $16,500 in 2015 (combining the $6500 you withdrew and the new $10,000 2015 contribution limit).
  • You may not ‘substitute’ or ‘swap’ shares in your TFSA with any other taxable or registered account.
  • You may contribute shares or other eligible securities, as long as the value of the investment you are contributing is within your limit. When you make a contribution with securities ‘in kind’, it’s a deemed disposition for tax purposes (even though you are not selling the securities) and the appreciated value is a realized capital gain. Be careful in selecting securities that have appreciated substantially as you will be claiming half of the growth as income on your tax return.
  • When selecting securities to contribute to your TFSA, look for ones that have appreciated modestly or are relatively the same value that you purchased them at, for tax reasons. If the securities that you wish to contribute ‘in kind’ have decreased in value you cannot claim the capital loss, so it may be a tax advantage to sell the shares, claim the capital loss and contribute the proceeds instead.

Great Tax and Estate Planning Strategies with the TFSA:

  • Consider contributing to your spouse’s TFSA to shelter additional investment income or to your 18-year-old children for that matter. Since the investment income is tax free, there is no tax attribution back to the contributor.
  • There are no Annual Account fees on a TFSA for accounts held in our Discretionary Portfolios.
  • TFSA accounts have a named beneficiary and therefore can be passed directly to that beneficiary upon the account holder’s death TAX FREE and PROBATE FREE!
  • You may name multiple beneficiaries on your TFSA.
  • Name your spouse as a ‘successor owner’ on your TFSA so that the funds can be rolled over to their TFSA and remain tax sheltered upon your death.

TFSA vs. RRSP:

The 2015 Federal Budget introduced an increased contribution to TFSAs, reheating the debate on whether contributing to an RRSP or TFSA is a preferred way to save. As with the ‘paying down the mortgage or save for retirement’ debate that raged in former years, the answer will differ for each individual, depending on their circumstances. Below are the three main rules of thumb:

  1. The higher your pre-retirement income level is, the better an RRSP is over a TFSA, since an RRSP provides a tax deduction on current income and a deferral of income.
  2. The higher your post-retirement income level is, the better a TFSA is over an RRSP, since RRSP withdrawals (and Registered Retirement Income Fund withdrawals) are taxed as income in the year they are taken out, increasing your already inflated income during retirement, and may result in Old Age Security benefit claw-backs and higher marginal tax rates.
  3. The closer you are to retirement and withdrawing money from your plan, the better a TFSA is over an RRSP, since the benefits of deferred income in an RRSP are diminished, the less time there is between the contribution date and the withdrawal date. The reverse is also true: the longer the funds are in your TFSA, the money that you saved on your income is used to invest in your tax-sheltered plan. In the same way that you can borrow to invest, this puts more money to work for you to earn capital growth, dividends and interest.

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  1. June 2015 Client Letter - SolinvestSolinvest - June 4, 2015

    […] that you to inform us if you’d like to top-up your TFSA contributions for the 2015 increase. Read more… *The annual contribution limit from 2009 to 2012 was […]

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