Last week we discussed reasons why an increased TFSA contribution limit is very helpful in building wealth for seniors. But the TFSA is an even more powerful tool for millennials, who should maximize their contribution room to build a tax-free retirement surplus that is potentially increased by the longer compounding time afforded to the young. Here are my top six reasons to consider the TFSA tool in year-end tax planning:
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 a higher earning spouse to transfer $10,000 to the lower earner each year for the rest of their lives to equalize savings pools. 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 – 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 3 – Later-Life Students: TFSA or LLP? Going back for a second degree? The source to tap for your education investment 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. If you don’t repay on time under this plan, the amount is included in income and taxed. That tax penalty 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 4 – 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, especially if you start when the child is very young. 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 5 – 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 $10,000 TSFA contribution maximum. This is particularly important for those who don’t have an employer-sponsored pension plan or are self-employed.
Reason 6 – 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 important for executives or business owners who earn more than the annual RRSP dollar maximum (this year that’s $24,930; arrived at when earned income reaches $138,500. The TFSA provides an opportunity to shore that retirement savings tax assistance with an additional $10,000 in 2015. Use these opportunities in conjunction with planning for funding of top-hat plans like Individual Pension Plans or Retirement Compensation Arrangements. Knowledge Bureau Faculty Member Larry Frostiak, FCA will discuss these opportunities at the Distinguished Advisor Workshop October 27 to Nov 2.