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ArticlesA Wealth of Choices: Understanding the New Tax-Free Savings Account
First Posted: April 16, 2008 Generally, TFSAs will work best with fixed income investments. But if you consider yourself a very good trader, you could trade stocks within the TFSA and profits will be tax-free. But, be wary. Capital gains inside a TFSA are tax-free, so you cannot claim a capital loss to offset other capital gains nor can you carry it forward. So if you own any laggard stocks, they would generally be wasted in a TFSA, while in a conventional investment account you can apply losses against taxable capital gains. Generally, high-income investors with extensive investments in non-registered plans might want to keep interest-paying investments in a TFSA and stocks outside. If you have small holdings outside a registered plan, you could consolidate into a TFSA. That could save you significant tax liabilities when you withdraw the money. It's not clear yet whether "in-kind" transfers from taxable plans to TFSAs would trigger capital gains. If such transfers were deemed a sale, you would be liable for capital gains taxes. If transfers weren't considered dispositions, you could conceivably reduce your unrealized capital gains liabilities over time. Similar to RRSPs, there is no limit on foreign content, potentially making the accounts a good place to park foreign investments that pay dividends or interest. Under conventional non-registered accounts, foreign dividends are considered income and are taxed at the full rate. They are not eligible for the dividend tax credit. In a TFSA those dividends would be tax free. If you happen to favour leveraged investing you can benefit by using a TFSA as collateral for low-interest investment loans. However, avoid using borrowed money to invest in a TFSA; the interest costs won't be deductible as they are in a conventional investment account. 2. Retirement planning: You may want to melt down your RRSP as you approach 65 years of age, pay a little tax while you are in a low tax bracket, and move the proceeds into TFSAs in order to minimize future clawbacks of Old Age Security benefits. In the year you turn 71, when you must convert your RRSP into an Registered Retirement Income Fund (RRIF) or an annuity, you could pay tax on the minimum RRIF payments and then move $5,000 of the remaining money into your TFSA each year, sheltering that income from taxes for the remainder of your life. The advantage here is maintaining tax-sheltered savings for emergencies or estate planning. TFSAs could also supplement RRSPs if you have maxed out your contribution room and still want to continue putting aside money for later years. 3. Estate planning: TFSAs will make it easy to bequeath large tax-free nest eggs. The amounts could total $1 million or more over 40 years of savings. TFSA holders can name spouses or common-law partners as beneficiaries and rollover the proceeds tax-free to them upon their death. Money in RRSPs or RRIFs is taxable on your final income tax return. 4. Income splitting: As with spousal RRSPs, spouses or common-law partners can contribute to their partner's TFSA. And when it comes to income splitting for taxes, attribution rules will not apply to income earned in a TFSA. 5. Pension plans: Some specialists suggest that low-income earners may choose TFSAs instead of employer-sponsored pension plans because the latter will generate taxes in retirement, while the former will not. The Fundamental Implication: TFSAs offer you an additional choice on how to manage your savings and investments. Consult with your accountant for the best ways to use this new account to maximize your wealth. Net Proceeds from Saving in a TFSA Relative to Other Types of Savings
** Tax rate on investment income is 28 per cent, representing a weighted average tax rate on an investment portfolio comprised of 30 per cent dividends, 30 per cent capital gains and 40 per cent interest. *** Forty per cent rate Article provided by Bennett Gold LLP, Chartered Accountants. Listen to their 'Business Smarts To Go' podcast series at BusinessCast.ca. |
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