How will the Canada Tax Free Savings Account Guard your Retirement Funds?
Registered or unregistered – that seems to be the question as Canadians plan and gear their savings and investment accounts toward retirement. Most experts advise that your investments gain a return in excess of two per cent in order to beat annual inflation. In addition, there are several tax strategies you should keep in mind as you allocate your investment dollars to specific accounts.
The Canadian Tax Free Savings Account (TFSA) allows for tax-free earnings off investments with aggressive return potential, yet only half of Canadians are utilizing this account – why is that? H&R Block suggests there are several myths acting as hurdles on the path to earning tax-free investment income.
Myth 1: a TFSA will affect Child Tax Benefit. TFSA funds are not included in annual income and thus will not affect GST/HST credit, nor will they decrease the amount of Child Tax Benefit you are eligible to receive.
Myth 2: I don’t have enough money to invest in a TFSA. TFSAs require no minimum sum in order to open one. In fact, their only real limitation is that you can only contribute $5,000 maximum per annum.
Myth 3: It’s no different than keeping my savings in a regular savings account. Wrong again. As soon as your savings account earns $50 or more in interest earnings per year it will be reported on a T5 and taxed accordingly. Plus the interest you receive on those savings will likely amount to less than two per cent.
Myth 4: I won’t have ready access to the money I invest in a TFSA. Incorrect! You can withdraw TFSA funds at your leisure, but unlike an RRSP, you won’t lose your annual contribution room. For example: if in 2011 you withdraw $2,000 from your TFSA, the following year you are allowed your $5,000 contribution sum plus the $2,000 you withdrew from the previous year, meaning you could contribute $7,000 in 2012. Even if you withdrew all of your TFSA funds in 2011, say to make a down payment on a home, that would mean you are eligible to contribute $5,000 for each of the years that the TFSA has been available (three years at current) carried forward.
Though TFSAs can be opened at virtually any financial institution, it is integral you discuss the investment options that are held within such to ensure they match the risk level you are comfortable with, and that they can beat inflation.
While all investments held within a registered account, such as an RRSP or RRIF, will be taxed at a marginal rate, non-registered investments are taxed differently depending on their origin. (Ex. in many parts of Canada dividends are taxed at a significantly lower rate than would interest or capital gains generated from stocks and equity mutual funds be.) Investments held within the TFSA will not be taxed at all.
In addition, registered accounts do not allow you to claim capital losses. Though TFSAs do not allow you to apply capital losses against investment returns made outside of the TFSA either, they do allow you to keep all of your capital gains made within, a large advantage over both registered and non-registered investment accounts held otherwise.
Consider this hypothetical scenario: in 2011 you opt to invest $5,000 in three different stocks in the medium risk category – stocks in reliable companies slated to be convalescing from yesteryear’s woes. In 2012 you do the same. In two year’s time that $10,000 has every chance of yielding a 20 to 100 per cent return; meaning that in 2013 you may have amassed a five per cent down payment on an attached rental property, which you can withdraw in its entirety from your TFSA with no funds lost to capital gains taxes.
In 2014 not only do you own a revenue-generating property, you also have a TFSA with a huge amount of room in it, into which you can rebuild your tax-sheltered investment savings.
Depending on the province or territory in which you dwell, sheltering dividend yielding investments in your TFSA could mean saving as much as a 30 per cent rate of taxation, while in other provinces it may mean little difference at all. Discuss your dividends strategy with your financial planner. You may also consider putting half of the preferred or common shares in your portfolio in your spouse’s name, enabling each of you to contribute $5,000 worth per year to your individual TFSAs.
Another item to keep in mind is that should your retirement income surpass the CRA-specified high income threshold, you could be subject to an Old Age Security clawback, meaning that a surcharge will be charged on every dollar for which you are over the “high income” limit until you have recovered the OAS payment.
While withdrawals from a RRSP or payments by a RRIF are considered taxable income, withdrawals made from a TFSA are not. This means that every year you contribute you are adding to a store of non-taxable income from which you can draw later down the road, which will not affect your Old Age Security.
Not only this, putting dividend-paying stocks into your TFSA could protect you from being pushed into a high bracket tax range for moneys you never receive, in a taxation practice termed a “gross-up”. Again, ask your financial planner what implications this could have on the retirement income you plan to derive from dividends.
TFSAs also make for a great landing pad for inheritance dollars. By 2018 a couple could have as much as $109,000 room in their TFSA to plant inheritance funds for tax-free growth. Combined with another tax-efficient strategy, such as using inheritance moneys to pay off the mortgage on a principal residence, large inheritances could completely avoid taxation following probate.
Finally, while it is illegal to use registered funds held in an RRSP as collateral on a loan, it is completely valid to use such held in a TFSA, though only the extremely savvy investor is recommended to take such an action. The moneys held in your TFSA may be leveraged to gain you access to loan dollars which you can use in turn for further investment. Remember you will be paying interest on this loan, thus the return your investment yields must be substantial. Alternatively, if your TFSA funds are tied into locked GICs or other products and you require instant emergency funds, this strategy may also be applied.
There is virtually no reason why you shouldn’t have a TFSA. They cost nothing to maintain and contribution room only grows over time. Contact your preferred financial institution to set up yours, and discuss the investment options you wish to hold within; those which will see you beat inflation and earn tax-free revenue.