Despite political controversy, the TFSA has gained broad-based acceptance by 40% or 11 million average Canadians.
More than 80% of all TFSA holders have incomes of less than $80,000, according to the April 21, federal budget documents. The opportunity now, is to take advantage of the immediate increase in the TFSA maximum contribution limit to $10,000 in 2015 and subsequent years.
In case you need any more convincing about the virtues of a tax free savings vehicle for family wealth creation, here are my top ten tax reasons why you shouldn’t miss taking a closer look at maximizing your TFSA investment:
Reason 1 - Family Income Splitting: There is no attribution rule attached to the TFSA because resulting income is tax exempt. So this is a great opportunity for parents and grandparents to transfer $10,000 each year to each adult child in the family—for the rest of their lives. Recipients can take the money out, tax-free, for whatever purpose they wish and create new TFSA contribution room in the process. That is, they can take withdrawals and, once they have accumulated new savings, can put those amounts back in future years to grow.
Reason 2 - New Tax-Sheltering Opportunities for RRSP Age-Ineligible Taxpayers: The RRSP tax shelter can continue for those who reach age 71 and have to convert their RRSP to a RRIF or annuity. Even if they don’t need the money, they are forced to take in withdrawals. Amounts not needed for their living expenses can be reinvested into a TFSA, allowing those tax-paid funds to grow again—and faster—in a tax-sheltered account, as opposed to a non-registered account.
Reason 3 - Benefits for Single Seniors: RRSP Melt-Down Strategy Enhancements. It has always made some sense to melt down RRSPs, converting to a RRIF or annuity and taking withdrawals, to “top income up to bracket” in circumstances where taxes will be higher at death than during life. We generally use that strategy for singles or widow(er)s for example. Now those surplus funds can be deposited into a TFSA so that retirees can continue to build wealth on a tax-free basis and keep legacies intact.
Reason 4 - Avoid High-Income Tax Brackets and Surtaxes: Savings within a TFSA are also a great way to reduce ongoing income tax burdens and taxes payable on death of a surviving single taxpayer. During life, untaxed RRSP accumulations do not qualify for income splitting in the hands of the surviving spouse. As a result, withdrawals can quickly be taxed in higher-income tax brackets now popular with provincial governments. Withdrawing some of these tax-sheltered accumulations before death (at lower tax brackets) and reinvesting in a TFSA can help to limit high tax obligations for the surviving spouse and ultimately for family heirs.
Reason 5 - Estate Planning Considerations: Note that the TFSA loses its tax-exempt status after the death of the plan holder, meaning the investment income earned after death will become taxable. However, a rollover opportunity is possible when the spouse or common-law partner becomes the successor account holder. This rollover will not be affected by the spouse’s contribution room, and will not, in turn, reduce their existing room either. In the case of a taxpayer dying without a spouse, the plan assets should be transferred to another appropriate savings vehicle.
Reason 6 - Homebuyers: TFSA or HBP? In the market to buy a first home? Consider whether it makes more sense to withdraw funds on a tax-free basis from within an RRSP to fund a new home purchase under the Home Buyers’ Plan, or to save the required funds in a TFSA instead and withdraw them from there when needed. There are no tax penalties for failure to pay back the funds to the TFSA (as there are with the RRSP), and withdrawals automatically create new TFSA contribution room, so our vote would be to accumulate money in the TFSA savings vehicle for the purposes of saving for a home instead of tapping into the RRSP.
Reason 7 – Later-Life Students: TFSA or LLP? The source of education savings should now be revisited as well, for similar reasons. Saving within the TFSA allows you to accumulate funds on a tax-deferred basis and then withdraw them without penalty or a requirement to repay the funds. This is not so under the Lifelong Learning Plan, which allows for a tax-free withdrawal from the RRSP but requires an annual repayment schedule. The avoidance of income inclusion penalties therefore makes the TFSA a more attractive withdrawal vehicle for later life students. Better to leave the funds in the RRSP for tax-deferred retirement savings.
Reason 8 –Education Savings for Minors: TFSA or RESP? Despite giving up Canada Education Savings Plan Grants and Bonds, the TFSA may appear to be a better savings vehicle for education purposes than the RESP. The latter could eventually attract a significant tax penalty on withdrawal if intended recipients do not end up going to school. Do the projection math to better understand how to manage this risk.
Reason 9 – Bolster Tax-Assisted Pension Contribution Limitations: Those who have contributed the maximum to an RRSP—18% of last year’s earned income to this year’s specific dollar maximum—and want to do more to supplement their savings on a tax-assisted basis, can now do so using an enhanced TSFA contribution maximum. This is particularly important for those who don’t have an employer-sponsored pension plan or the self employed.
Reason 10 - Supplementing Executive Pension Funding: Contributors to employer pension plans are often precluded from making RRSP contributions because of their pension adjustment amount. The TFSA now gives these people the opportunity to tap into another tax-preferred savings opportunity. This is particularly important also for executives who earn more than the annual dollar maximum. The TFSA provides a small window of opportunity to shore that tax assistance up. This option should be used first and then in conjunction with planning for funding of top-hat plans like Individual Pension Plans or Retirement Compensation Arrangements.