TFSAs: the ultimate tax-slashing tactic

For continuous long-term tax- and wealth-planning

For most of us, tax-filing time has come and gone for another year. And, for most of us, so has our focus on cutting taxes for another year. Before you let it go completely, spare one last moment to consider the ultimate tax-slashing tactic – one that you can start using today. It’s called the Tax-Free Savings Account (TFSA), and it’s the best tax shelter now available to Canadians. Here’s a look at how it works and how to make the most of it.

Almost everyone is eligible to open a TFSA. And everyone should. Investments made with funds contributed to a TFSA grow completely tax-free inside the plan. And the icing on the cake is that when you withdraw funds from the TFSA, absolutely no tax is payable either.

The annual contribution limit for Tax-Free Savings Accounts (TFSA) has risen to $6,000 in 2019, and it is not income-dependent or limited by contributions to other plans like RRSPs or RPPs. Unused contributions can be carried forward to future years, bringing total contribution room available since the introduction of the plan in 2009 to $63,500 for someone who has never contributed to a TFSA.

There’s no deadline date for contributions for the year, because there is no tax deduction available for contributions as there is for RRSPs. You can contribute any amount at any time you want through the year, as long as you don’t exceed your maximum. You have to be over 18 and a have a valid Canadian Social Insurance Number.

You can invest in the same types of “qualified investments” as you would in an RRSP – which covers a lot of ground: stocks, bonds, GICs, mutual funds, ETFs, and more. As with RRSPs, however, you lose the benefits of the dividend tax credit, the capital gains exemption, and the use of capital losses within the TFSA.

Is the TFSA worthwhile, even though there’s no tax deduction of annual contributions? Let’s say you are 30 years old today, you make $60,000 a year, and you are able to contribute $31,000 to your TFSA right away. If you then continue to contribute $6,000 every year until you retire at age 65 (that’s $500 per month), at an average compounded annual rate of return of 8%, your TFSA would grow to $1,536,522! Contributing even $300 per month would result in a nest-egg of $1.1 million at retirement. The interest, dividends, and capital gains generated in the TFSA are all tax free. And all withdrawals are tax free. It’s the tradeoff for using after-tax dollars to make contributions.

TFSAs have some tax-planning side benefits as well. For example, because attribution rules do not apply, income from investments in a plan you fund for your spouse or child over 18 is tax free. However, your spouse or child must be the registered holder of the TFSA, so it’s best to make a gift of the funds and let the TFSA holder make the contribution.

For retirees, taxable withdrawals from a RRIF that are not needed as living expenses can be contributed directly to a TFSA (not exceeding the annual maximum, of course), to continue growing completely tax free. This is possible because there is no age limit or maturity considerations for TFSAs as there are for RRSPs.

One tax trap to watch for with TFSAs is overcontribution in a year. This is easy to fall into if you have a tendency to use your TFSA as an ATM. If you frequently dip into it when you’re short of funds, and then top up again when you’re flush without keeping an eagle eye on your transaction, you could end up with “excess amounts” in your TFSA – that is, over and above the $6,000 annual contribution limit for the year.

That’s when a tax penalty of 1% per month kicks in. It’s based on the highest excess TFSA amount in your account for each month in which an excess exists. This means that the 1% tax applies for a particular month even if an excess amount was contributed and withdrawn later during the same month. The excess-amount tax kicks in on the first dollar of excess contributions.

The TFSA is a great way make sure you save tax all year round, not just in April. But the rules can get complicated. If you’re in a high net worth bracket, it makes a lot of sense to consult with a qualified financial advisor to ensure you make the best use of a TFSA in your overall tax and financial planning.

Robyn Thompson, CFP, CIM, FCSI, is the founder of Castlemark Wealth Management, a boutique financial advisory firm specializing in wealth management for high net worth individuals and families. Contact her directly by phone at 416-828-7159, or by email at rthompson@castlemarkwealth.com for a confidential planning consultation.

Notes and Disclaimer

The foregoing is for general information purposes only and is the opinion of the writer. Securities mentioned are illustrative only and carry risk of loss. No guarantee of investment performance is made or implied. It is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. Please contact the author to discuss your particular circumstances.