Tax Free Savings Accounts
September 24, 2008 – 9:54 amTFSA coming next year, here’s the summary from MDJ:
The Details:
- Starting 2009, anyone aged 18 or older can contribute $5000/yr to the TFSA.
- The TFSA can grow and be withdrawn completely tax free.
- You never lose contribution room even when withdrawn.
- Withdrawals can be made at ANY TIME with no withholding tax.
- Contribution room can be carried forward indefnitely.
- You can contribute to a spousal TFSA, and they can withdraw from it tax free (income splitting).
- Withdrawal income does not affect government benefits like OAS, GIS, or CCTB.
The Fine Print:
- Contributions are not tax deductible.
- Capital losses cannot be claimed.
The Possiblities:
- The account can be used as a simple savings account where interest can grow tax free.
- This could be an opportunity for stock trading pros to utilize their options/shorting strategies without their gains being taxed as income.
- An opportunity for income splitting where couples now have double the TFSA room to play with.
- Invest in strong foreign dividend companies and withdraw the dividends TAX FREE. Right now, if you receive foreign dividends, they are taxed at your marginal rate. If you put these foreign dividends in an RRSP, they grow tax free, but you are taxed when you withdraw. The TFSA provides a great way to get exposure to those juicy American dividends, tax free at that.
- Invest in higher yield bond funds/income trusts and withdraw distributions as a tax free income supplement.
- Opportunity for non-registered portfolio rich seniors to move their dividend paying stocks into a TFSA to prevent OAS reduction.
Further, regarding TFSA vs RESP:
The calculations confirm my suspicion that it is more profitable to save for your child’s education in a RESP by contributing just enough to get the maximum CES grant. But it now makes no sense to contribute the maximum 50K allowed to a RESP over time. It is better to channel any contribution that doesn’t receive a matching grant into a TFSA instead.
More articles on TFSAs on the Canadian Capitalist, especially RRSP vs. TFSA vs. Mortgage Paydown, and another on MDJ on TFSA vs. RRSP.
*It’s important to keep in mind that the contribution limit is $5,000.00. Meaning if you put in $5,000.00 and withdrew $2,000.00 in the same year, that you cannot “refill” the TFSA with another contribution of $2,000.00 until the following year.
Here’s a chart from here showing the difference:
| TFSA | RRSP | Unregistered savings |
|
| Pre-tax income | 1,000 | 1,000 | 1,000 |
| Tax (40% rate) | 400 | 0 | 400 |
| Net contribution | 600 | 1,000 | 600 |
| Investment income (20 years at 5.5%) | 1,151 | 1,918 | 707 |
| Gross proceeds (net contribution plus investment income) | 1,751 | 2,918 | 1,307 |
| Tax (40% rate) | 0 | 1,167 | 0 |
| Net proceeds | 1,751 | 1,751 | 1,307 |
| Net annual after-tax rate of return (%) | 5.5 | 5.5 | 4.0 |
|
|
|||
| Source: Finance Department | |||
2 Responses to “Tax Free Savings Accounts”
Comment on FWF:
http://www.financialwebring.org/forum/viewtopic.php?p=300738#300738
Intuitively this means that you want to put the better performing investments in the TFSA, and the worse performing investments in the RRSP - since the benefit of the RRSP (tax break on input) occurs regardless of your returns, while the benefit of the TFSA (tax break on growth) is directly proportional to how much growth occurs (no growth, no break).
The math showing that they are equivalent is flawed in that it ignores the fact that investments in both vehicles are capped - effectively it assumes that your RRSP investment is larger to start wtih because of the pre-tax input, and that exactly cancels out with TFSA on the back end due to additional tax on withdrawal (on a higher principal) - but simply contributing to an RRSP does not increase your RRSP room, yet calculations that show them as equivalent implicitly assume this!
The flaw here is here is that many people will be a situation to maximize one of or both their RRSP and TFSA (especially those with minimal RRSP room due to low income, non residency or pension adjustment), and this means that you cannot compare pre-tax dollars in an RRSP with after-tax dollars in the TFSA, because contribution room is always consumed by after tax dollars.
…
The moral of the story is that if you are investing in both an RRSP and the TFSA, you should favor putting higher growth/yield investments in the TFSA.
By Patch on Jan 28, 2009
Contribution Room explanation:
http://www.milliondollarjourney.com/tfsa-contribution-room.htm
So yes, you can recontribute the amount you withdrew the year before…awesomesauce!
By Patch on Jan 28, 2009