KEY007 - Dispelling the myths and misconceptions surrounding Tax Free Savings Accounts
1. 04 In This Edition
1.1. In this edition of The Key To Retirement, I'm going to dispel the myths and misconceptions surrounding Tax Free Savings Accounts.
1.2. And, in today's bonus segment we're going to reveal to you a website that you can go to to learn virtually any piece of software or internet application - 24 hours a day, 7 days a week - right from your own computer.
2. 05 What's New?
3. 07 Feature Segment
3.1. The good, the bad and the ugly when it comes to Tax Free Savings Accounts.
3.1.1. You've see the ads at your bank.
3.1.1.1. Buy your TFSA's here!
3.1.2. Your bank teller has asked if you've bought yours yet.
3.1.3. We're going to review everything you need to know about TFSA's so you can make an informed decision about whether or not a TFSA is right for you.
3.2. Let's dispel the most common myths and misconceptions about TFSA's.
3.2.1. Myth #1 - A Tax Free Savings Account is for savings
3.2.1.1. Yes, but it can be sooo much more.
3.2.1.2. Powerful investing solution if set up properly.
3.2.1.3. The name is misleading.
3.2.1.3.1. The name kind of makes people think "why bother?"
3.2.1.3.2. Savings = low interest
3.2.1.3.3. Should have been called the Tax Free Investing Account or Tax Free Account.
3.2.1.3.4. Used properly, it can be a powerful investing tool.
3.2.1.4. Qualifying investments are generally the same as those that can go into an RRSP.
3.2.1.4.1. Cash
3.2.1.4.2. GIC's
3.2.1.4.3. Mutual Funds
3.2.1.4.4. Bonds
3.2.1.4.5. Certain shares of small business corporations
3.2.1.5. Since you get to keep 100% of the profits generated, why settle for savings account returns?
3.2.2. Myth #2 - TFSA withdrawals will cause claw-backs of government benefits.
3.2.2.1. Not true.
3.2.2.2. Withdrawals are tax free.
3.2.2.3. All withdrawals will not affect income tested government benefits.
3.2.2.3.1. Old Age Security (OAS)
3.2.2.3.2. Guaranteed Income Supplement (GIS)
3.2.2.3.3. Employment Insurance (EI)
3.2.2.3.4. Eligibility for
3.2.3. Myth #3 - Use it or lose it! If you don't make a contribution this year, you lose that contribution room.
3.2.3.1. Not true.
3.2.3.2. Eligibility requirements
3.2.3.2.1. 18 years of age or older
3.2.3.2.2. Canadian resident.
3.2.3.3. Whatever you don't use, carry's forward and is added to next year's benefit.
3.2.3.4. Program started in 2009.
3.2.3.5. In fact, if you have a TFSA and make a withdrawal from the account, the amount of the withdrawal gets ADDED to your contribution room at the beginning of the following year.
3.2.4. Myth #4 - Always maximize your RRSP first, then contribute to your TFSA.
3.2.4.1. Everyone is unique and so is their tax situation.
3.2.4.2. There is no one size fits all.
3.2.4.3. The answer is - it depends.
3.2.4.4. Here are some guidelines:
3.2.4.4.1. If your tax rate when you retire is going to be the same as it is now, the TFSA and the RRSP are equally effective tax-savings alternatives.
3.2.4.4.2. If your tax rate at the time of withdrawal is going to be lower than at the time of contribution, the RRSP is the better choice.
3.2.4.4.3. If your tax rate at the time of withdrawal is going to be higher than at the time of contribution, the advantage goes to the TFSA.
3.2.5. Myth #5 - A TFSA must be transferred, used up or completely withdrawn by a certain age.
3.2.5.1. Unlike the requirement to convert an RRSP to a RRIF and the resulting shift from contribution to mandatory withdrawals, the TFSA has none of these restrictions.
3.2.5.2. You are free to do what you want, when you want.
3.2.5.3. Withdrawal your funds anytime for any reason with no negative tax consequences.
3.2.5.3.1. No withholding tax because withdrawals are not taxable.
3.2.5.3.2. No income to be reported on your tax return because the withdrawals are not taxable.
3.2.6. Myth #6 - Since it's made in Canada, everything in the plan must be 100% Canadian.
3.2.6.1. Not at all.
3.2.6.2. As I said earlier, all of the qualifying investments are the same types as the qualifying ones for Registered Retirement Savings Plans.
3.2.6.2.1. Cash
3.2.6.2.2. GIC's
3.2.6.2.3. Mutual Funds
3.2.6.2.4. Stocks
3.2.6.2.5. Bonds
3.2.7. Myth #7 - You are not allowed to have multiple TFSA accounts.
3.2.7.1. You can have as many as you like.
3.2.7.1.1. Not recommended though, keep things simple.
3.2.7.2. However, contribution limits are where the rules get strict.
3.2.7.3. Contribution limits are calculated per individual, not per account.
3.2.7.4. Care must be taken not to over-contribute
3.2.7.4.1. 1% per month penalty on excess contributions.
3.2.8. Myth #8 - Tax Free Savings Accounts are protected from creditors
3.2.8.1. Assets within a TFSA are not protected from creditors in the event of bankruptcy or a financial judgement that results from legal proceedings against you - whereas assets in an RRSP are protected.
3.2.8.2. 1 Exception
3.2.8.2.1. The exception to this is if you hold your TFSA with an insurance company and invest in segregated funds.
3.2.9. Myth #9 - TFSA's cannot be used as collateral for a loan
3.2.9.1. Because TFSA's are seen as another form of tax-sheltered investment, people often times assume that the rules for RRSPs apply.
3.2.9.2. This is not the case.
3.2.10. Myth #10 - Investment income generated within a TFSA are tax-free for everyone
3.2.10.1. If you are a US taxpayer who is resident in Canada - watch out.
3.2.10.2. Remember, TFSA's are truly Canadian.
3.2.10.2.1. Income earned in a TFSA is taxable on a current year basis in the US. So, if you are a US taxpayer resident in Canada, you are required to report the income earned in an TFSA account.
3.2.10.3. Strategy for US taxpayers in Canada
3.2.10.3.1. Consider withdrawing your TFSA funds.
3.2.10.3.2. The withdrawal will not be taxable in Canada or the US and the amount you withdrawal will reinstate contribution room for future years.
3.2.10.3.3. If the IRS relieves the taxation of TFSA's in the future, the renewed contributjion room can be used efficiently.
3.3. Strategies suitable for everyone
3.3.1. Transfer investments that typically produce highly taxable income (such as bonds and foreign dividend-paying stocks) into the TFSA to take advantage of tax-free growth.
3.3.2. Always contribute the maximum amount ($5,000 per individual) to the TFSA before holding investments in non-registered accounts.
3.3.3. If your income is low today with the expectation that it will go up in subsequent years, contribute to the TFSA first and the RRSP second. The ability to carry forward the unused RRSP contribution amounts to future years will provide you with valuable contribution room in the years you need it most.
3.3.4. If your income is high today, contribute to the RRSP first and the TFSA second. Take advantage of the tax deduction you received from RRSP contributions today.
3.3.5. After taking advantage of tax-loss selling strategies, buy back the investment inside a TFSA to get a tax-free benefit on any potential rebound on that investment (after the superficial loss period elapses)
3.4. Strategies suitable for Middle-Age Investors or Those In Peak Earning Years
3.4.1. Using an 'income splitting' strategy, a higher income earning spouse can give money to the lower earning spouse for contribution to the lower earning spouse's TFSA, with no attribution.
3.4.2. Invest tax refunds in the TFSA when RRSP contribution room is used up.
3.4.3. TFSA's can be used to supplement a child's education if RESP contributions have been used up.
3.4.4. People with variable income from year to year can use an 'Income Smoothing' technique to maximize deductions
3.4.4.1. In lower income years, contribute to the TFSA instead of the RRSP to build up contribution room for higher income years.
3.4.4.2. In higher income years, withdraw the TFSA assets and use them to contribute to carried-forward RRSP contribution room in order to reduce income taxes paid.
3.4.5. Those in their peak-earning years, who want to set aside money regularly to pay off a mortgage at the end of the term can contribute to their TFSA, where the money can grow tax-free.
3.5. Strategies suitable for Seniors / Retirees
3.5.1. Use a TFSA as the first source of income before using RRSP/RRIF withdrawals as there are no taxes on TFSA withdrawals.
3.5.2. If minimum required RRIF withdrawals are in excess of funds needed, retirees can contribute this surplus to a TFSA.
3.5.3. Minimize Old Age Security clawbacks by holding income producing assets in a TFSA to lower reported income.
3.5.4. In estate planning upon death, TFSA assets can be transferred tax-free to a retiree's spouse's TFSA without affecting the spouse's contribution room.
3.5.5. Use TFSA's for gifting to adult children or grandchildren.
3.6. Did you mistakenly over-contribute to your Tax Free Savings Account?
3.6.1. CRA is willing to be flexible to those who mistakenly over-contributed to their TFSA.
3.6.2. During the TFSA launch in 2009, approx. 6.7 milion Canadians opened a TFSA.
3.6.3. During the initial year of the TFSA, there was a lot of confusion and as a result, a lot of Canadians received nasty letters from CRA informing them of their over-contributions and corresponding penalties.
3.6.4. CRA has stated that they are willing to work with all Canadians who made honest contribution mistakes.
3.6.5. According to CRA, "Every TFSA holder who receives a letter indicating that they may have over-contributed will be able to ask the CRA to review their specific file and, where appropriate, waive taxes on excess contributions.
3.6.6. If you received one of these letters, it is important that you contact CRA immediately if you want this administrative relief. Your response should be made within 60 days of the letters receipt.