The Tax-Free Savings Account (TFSA)
How To Incorporate It Into Your Financial Plan
This article discusses the flexibility of a TFSA. Depending on your stage of life and your financial priorities, there are strategies that can help you get the most from your TFSA.
Overview - TFSAs are a type of registered plan, and like all registered plans, your contributions grow inside the plan without attracting tax; but the TFSA has some additional flexibility. Funds can be withdrawn tax-free at any time but you don’t need to withdraw or take income from them until you are ready to do so. This means they can be used for a wide range of goals. There are also some opportunities to income split to reduce the overall household income tax. You don’t need to have earned income to contribute to a TFSA, although you do need to watch your contribution limits to avoid paying penalties for inadvertently contributing too much.
Gifts to a Spouse - If there is a lower-income spouse in your household, you may be able to benefit from income-splitting opportunities using the TFSA. When a higher-income spouse provides funds to their lower-income spouse to contribute to their TFSA, because the income and capital gains earned in the TFSA are tax-free, there will be no attribution back to the higher income spouse. Unlike a non-registered account, the income attribution rules will not apply to the income and capital gains earned in the TFSA.
This may help achieve family income splitting, plus, as the funds in the account accumulate tax-free, there is no impact on any spousal tax credits that the higher-income spouse may be able to claim for the lower-income spouse.
Gifts to Adult Children - You can use a TFSA, in addition to a registered education savings plan (RESP), as a tax-sheltered way to supplement savings for your child’s education. If you gift funds to a child who is at least 18 years old (in Ontario), they can contribute to a TFSA. They will not pay tax on the investment income they withdraw from the TFSA as they would with RESP withdrawals. Note however that once you make the gift, you will no longer be able to control how it is invested, when and how much is withdrawn and how the money is used.
Opportunities for Retirees - Retirees may be one of the major groups to benefit from the TFSA. Here’s a summary of some of the potential opportunities:
If you are no longer working but have cash flow that you don’t need right away, you can continue building your savings even though you no longer have earned income with which to generate RRSP contribution room. The TFSA provides a way to save in a tax-free environment.
You can contribute to this tax-free savings vehicle even after the end of the year you turn 71 when you are no longer able to contribute to your RRSP. If you are receiving either the required annual minimum registered retirement income fund (RRIF) income or pension income that is in excess of your current needs, then consider contributing the excess to your TFSA to preserve some tax-free growth.
If you anticipate being in the same or a higher marginal tax bracket in retirement, a TFSA could provide another source of tax efficient retirement income.
Another advantage of using a TFSA to complement your existing sources of retirement income is that, as withdrawals from the account are not taxable income, they do not have an impact on any federal income tested benefits and credits you may receive (such as the Guaranteed Income Supplement, Age Credit or the Old Age Security (OAS) claw back.
The TFSA Can Complement Your Existing Registered Savings Plans - Depending on your financial circumstances and your stage of life, you may be able to use the TFSA to complement your existing registered savings plans in the following ways:
If you have maximized your RRSP contributions based on your available contribution room or if you can no longer make RRSP contributions due to your age, you could use your TFSA to earn additional tax-sheltered investment income. You can withdraw funds from the account when you need them and re-contribute them without tax consequences in the following year.
You may wish to consider using your TFSA to accumulate funds in addition to an RESP. This could be another tax-sheltered way to save for a child’s education.
If you have investments in non-registered accounts, consider contributing them in-kind to your TFSA, up to your allowable TFSA contribution limit. This could trigger capital gains, which may result in an immediate tax liability.
If you are unable to fund both an RRSP and a TFSA during your peak earning years when you are in a higher tax bracket, contributing to your RRSP may make sense to give you the benefit of the income tax deduction. You could then withdraw the funds from your RRSP when you are in a lower tax bracket, possibly in retirement, and contribute to a TFSA to generate tax-free investment income that you can access whenever you need it.
If you are able to make contributions to your TFSA and are looking for an additional source of retirement income in future years, you may enjoy the flexibility of being able to withdraw funds from the account without tax consequences when you need them. Then in future years you can re-contribute the funds you have withdrawn since these withdrawals create new contribution room in the year after the withdrawal.
Create an Emergency Fund - You may wish to use the TFSA to help create an emergency fund. As these funds may be needed urgently and have to hold their value, consider more secure, less volatile interest earning securities. As interest in a non-registered account is not favourably taxed, compared with Canadian dividend income and capital gains, the TFSA may be a great place to shelter your interest income producing investments. You could earn interest income on the funds tax-free and have access to them when you need them. Consider using your TFSA as a complement to a line of credit as another way to meet unexpected expenses. If you are considering borrowing funds to invest in a TFSA as part of your overall financial plan, note that you will not be able to deduct the interest you pay on the borrowed funds.
Summary - The TFSA offers greater flexibility in saving and investing throughout your lifetime and can provide a source of income in retirement. If you make the maximum contribution to your RRSP every year and are looking for additional ways to shelter investment income and capital gains from taxation, a TFSA can be a great complement even though you will not receive a deduction for the amount of your contribution.
Lastly, if you would like to receive a more comprehensive 7-page article entitled, How the TFSA can help you reach your financial goals, please feel free to request one.
Susan Gottlieb is Vice President and Wealth Advisor with RBC Dominion Securities Inc. This article is for information purposes only. Please consult with a professional advisor before taking any action based on information in this article.
This document has been prepared for use by the RBC Wealth Management member companies, RBC Dominion Securities Inc. (RBC DS)*, RBC Phillips, Hager & North Investment Counsel Inc. (RBC PH&N IC), RBC Global Asset Management Inc. (RBC GAM), Royal Trust Corporation of Canada and The Royal Trust Company (collectively, the “Companies”) and their affiliates, RBC Direct Investing Inc. (RBC DI) *, RBC Wealth Management Financial Services Inc. (RBC WM FS) and Royal Mutual Funds Inc. (RMFI). Each of the Companies, their affiliates and the Royal Bank of Canada are separate corporate entities which are affiliated. *Members-Canadian Investor Protection Fund. “RBC advisor” refers to Private Bankers who are employees of Royal Bank of Canada and mutual fund representatives of RMFI, Investment Counsellors who are employees of RBC PH&N IC, Senior Trust Advisors and Trust Officers who are employees of The Royal Trust Company or Royal Trust Corporation of Canada, or Investment Advisors who are employees of RBC DS. In Quebec, financial planning services are provided by RMFI or RBC WM FS and each is licensed as a financial services firm in that province. In the rest of Canada, financial planning services are available through RMFI, Royal Trust Corporation of Canada, The Royal Trust Company, or RBC DS. Estate & Trust Services are provided by Royal Trust Corporation of Canada and The Royal Trust Company. If specific products or services are not offered by one of the Companies or RMFI, clients may request a referral to another RBC partner. Insurance products are offered through RBC Wealth Management Financial Services Inc., a subsidiary of RBC Dominion Securities Inc. When providing life insurance products in all provinces except Quebec, Investment Advisors are acting as Insurance Representatives of RBC Wealth Management Financial Services Inc. In Quebec, Investment Advisors are acting as Financial Security Advisors of RBC Wealth Management Financial Services Inc. RBC Wealth Management Financial Services Inc. is licensed as a financial services firm in the province of Quebec. The strategies, advice and technical content in this publication are provided for the general guidance and benefit of our clients, based on information believed to be accurate and complete, but we cannot guarantee its accuracy or completeness. This publication is not intended as nor does it constitute tax or legal advice. Readers should consult a qualified legal, tax or other professional advisor when planning to implement a strategy. This will ensure that their individual circumstances have been considered properly and that action is taken on the latest available information. Interest rates, market conditions, tax rules, and other investment factors are subject to change. This information is not investment advice and should only be used in conjunction with a discussion with your RBC advisor. None of the Companies, RMFI, RBC WM FS, RBC DI, Royal Bank of Canada or any of its affiliates or any other person accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or the information contained herein. ® Registered trademarks of Royal Bank of Canada. Used under license. © 2016 Royal Bank of Canada. All rights reserved. NAV0106-EN (01/2016)
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