Tax Managed Strategy 17
Tax Free Savings Accounts (TFSAs) can be an excellent savings vehicle, however, consideration should be given to who can best benefit from using them as well as why and how you could use them. Provided you have no credit card debt, TFSAs may be your first choice for non Registered Retirement Savings Plan (RRSP) contributions each year. Following is a list of things to consider.
Since TFSAs do not benefit from the tax-efficiency of dividends or capital gains, it is generally a good idea to use them for the least tax-efficient investments, such as those that pay interest. Another consideration, depending on your risk tolerance, would be to put speculative or highly risky investments into a TFSA and hope that a $6,000 deposit grows, for example, to $30,000 or $50,000 which then could be withdrawn tax-free. The risk is that if the investment does poorly, capital losses are not available to you.
Gradual transfer of other assets
You may want to consider withdrawing funds from other assets, both registered and non-registered and contributing it to your TFSA. Guaranteed Interest Contracts (GICs), for example, where the tax on the interest is paid on an ongoing basis, may be a good asset to switch to a TFSA and allow future interest to grow tax-free. You may also want to consider transferring market-based assets or even making RRSP withdrawals if you are concerned that you will lose income tested benefits in retirement. The tax paid now may very well offset the impact of reduced benefits in retirement. Remember that if you are transferring market-based assets in kind to a TFSA that it will trigger a capital gain or capital loss and that a capital loss would be denied. So, if you are in a loss position it may be better to sell the investment and trigger the loss and then contribute the cash to the TFSA.
Every Canadian age 18 and over will have TFSA room but may not have the means to make a TFSA contribution. Income attribution does not apply, so you may want to consider providing the funds to your spouse¹ , so they can make a contribution, thereby increasing the amount of your combined investments that will grow on a tax-free basis.
Consider naming your spouse as successor holder of your TFSA. By doing this, the tax-free status of the investment earnings can continue after death.
All provinces, except Quebec, have introduced legislation allowing the designation of beneficiaries on a TFSA. If a spouse is named as beneficiary, an amount up to the value of the TFSA at the time of death can be contributed to his or her TFSA without affecting their TFSA contribution room if the contribution is done prior to the end of the year following the year of death and is designated as an exempt contribution. However, any income earned between the date of death and the contribution will be taxable to the spouse.
It’s often suggested that where permitted, the holder names their spouse as successor holder instead of a beneficiary. On the holder’s death the spouse will automatically become the new holder of the TFSA. The TFSA continues to exist and both its value at the date of death and any income earned after that date continue to be sheltered from tax under the new successor holder. In addition, naming a spouse as successor holder can help avoid the administration and filing requirements necessary to preserve the tax-free status of the TFSA funds when a spouse is named as beneficiary.
Whether naming your spouse as a beneficiary or successor holder of your TFSA, both have the advantage of having the proceeds bypass the estate. In addition, there is the potential for creditor protection on insurance company issued TFSAs.
If you have funds earmarked for your children, you may want to consider a gradual transfer of those assets to your adult children now. While this may trigger a capital gain, you can freeze the amount of capital gains paid by having future investment earnings grow tax-free, thereby possibly minimizing taxes in your estate later.
A TFSA could be used to supplement your retirement savings if you are in a situation where you can’t contribute to an RRSP. For example, you may receive dividend income rather than earned income, or you may belong to a pension plan where the pension adjustment limits your RRSP contribution.
A TFSA may not replace Registered Education Savings Plans (RESPs) for education savings because of the grants and the fact that the holder of a TFSA must be at least 18 years old. However, you could provide education savings for your older children, those in university, for example, by providing dollars to contribute to their own TFSA. Alternatively, you could use your TFSA room to supplement the high cost of education when RESP savings is not enough.
Strategies by income level
A TFSA may be a great savings vehicle if you are in a low income tax bracket. RRSPs may not be well suited to low income Canadians. If you previously made RRSP contributions and now find yourself in a lower tax bracket, such as when on maternity leave, you may want to consider making a withdrawal from your RRSP to make a TFSA contribution.
One strategy would be to contribute to your TFSA now and accumulate RRSP room, to be used later when in a higher tax bracket to help optimize the tax benefits. Rainy day or emergency savings would also be appropriate for a TFSA.
This is a situation where you may want to maximize both your RRSP and TFSA contributions. In fact, the tax savings or tax refund received from the RRSP contribution could be used to fund the TFSA.
If you have more income than you need to live on, consider investing the difference in a TFSA. Since you’re already paying tax on it and investing the remainder, why not let it grow tax-free? This excess income may be in the form of forced Registered Retirement Income Fund (RRIF) minimum withdrawals due to age or taking Canada/ Quebec Pension Plan (CPP/QPP) income but still working. It could also be from receiving excess income from mutual fund distributions or from the many investments that provide an income stream that is primarily a return of capital, such as Series T funds.
Impact on income tested benefits
Federal income tested benefits such as Old Age Security (OAS), the Guaranteed Income Supplement (GIS) and child tax benefits will not be impacted by TFSA assets or withdrawals. Other provincial programs such as disability support, student loans, or nursing homes that factor in assets and/or income may be impacted. The impact is likely a reduction of such benefits, but this varies by province and program.
Investment options with Manulife
Manulife and its subsidiaries provide a range of investments and services including:
Mutual funds from Manulife Investments can help meet your specific financial needs, throughout your life. Whether you are just starting out, accumulating wealth or are nearing/in retirement, mutual funds offered by Manulife Investments, can provide you with solutions to help build a portfolio that meets your needs. Manulife is committed to providing quality investment products and services.
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The Manulife Investments Guaranteed Interest Contract (GIC) offers competitive rates plus investment options. Investors benefit from a guarantee on their principal investment and from several different investment options that can diversify and add flexibility to their portfolio. Manulife Investments GICs can be a great solution for conservative investors looking to help grow their wealth, but who are also concerned about minimizing risk.
1 Includes a spouse or common-law partner as defined by the Income Tax Act (Canada).
The commentary in this publication is for general information only and should not be considered investment or tax advice to any party. Individuals should seek the advice of professionals to ensure that any action taken with respect to this information is appropriate to their specific situation. Any amount that is allocated to a segregated fund is invested at the risk of the contractholder and may increase or decrease in value. The Manufacturers Life Insurance Company is the issuer of Manulife segregated fund contracts and the Manulife Investments Guaranteed Interest Contract (GIC) and is the guarantor of any guarantee provisions therein. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the fund facts as well as the prospectus before investing. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated. The payment of distributions is not guaranteed and may fluctuate. If distributions paid by the fund are greater than the performance of the fund, then your original investment will shrink. Distributions should not be confused with a fund’s performance, rate of return, or yield. You may also receive return of capital distributions from a fund. Please consult with your tax advisor regarding the tax implications of receiving distributions. See the prospectus for more information on a fund’s distributions policy. Manulife Funds and Manulife Corporate Classes are managed by Manulife Investments, a division of Manulife Asset Management Limited. Manulife, Manulife & Stylized M Design, and Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.