I’m trying to think of some various strategies for using the TFSA:
1. If you have a non-registered account with corporate class mutual funds and they have a t-class available for ROC distributions, you could elect to start the ROC withdrawals and slowly convert the portfolio into the TFSA account. Eventually your ACB will be ground down to zero in the non-registered account, but you will also be transferring to a tax-sheltered environment without having to pay the higher fee associated with corporate class funds.
2. There is a huge opportunity for estate planning as you can pass TFSA assets tax-free to your spouse, and then to your children. Assuming the children will be building up unused room then might even have the means to accept the transfer right into a TFSA of their own.
3. You can maximize your RRSP and put the refund into the TFSA.
4. You can contribute to an RRSP in a high-income year and make a withdrawal in a low income year (capitalizing on the differential between tax rates) and then place the withdrawal in your TFSA.
5. I can see the TFSA being the savings vehicle of choice for low-bracket Canadians’ retirement, and the RRSP might be used for pre-retirement expenses (if the TFSA gets maximized).
6. The TFSA might replace standard savings accounts for the younger generations since many will probably not be able to keep up with the contribution room generated.
7. The TFSA will be very helpful to single income families since they will still have $10,000 in room generated per couple, all of which can be used up by the income earner.
8. A non-resident can maintain a TFSA. No new contribution room is generated so long as they are non-resident, but the account remains tax-sheltered. They can not make new contributions as well (even if they had unused room).
9. If you use both an RRSP and a TFSA, it might make sense to put the equities in your TFSA since if they are expected to grow faster than fixed income investments over a long period of time and the withdrawal of funds will not be taxed, this will be advantageous at time of withdrawal.
So for example, if you put $1,000 into each of the RRSP and TFSA account and lets assume a 40% tax bracket now and 30 years from now, then we also need to factor re-investment of the $400 RRSP refund. Let’s assume it goes back to the RRSP for a total RRSP contribution of $1,400. The $1,400 RRSP amount is fixed income and grows at 5% for 30 years. That grows to $6,050.72. The $1,000 TFSA in in equities and grows at 10%, and after 30 years is worth $17,449.40. If you took out all money, you would have no tax on the TFSA withdrawal, and $2,420.29 in tax on the RRSP withdrawal for a net after-tax amount of $21,079.83.
If it was the other way around, then you would have $1,000 in the TFSA earning 5% as fixed income being worth $4,321.94 in 30 years. The $1,400 RRSP contribution would have grown to $24,429.16 at 10% over 30 years. The TFSA withdrawal is still tax free, but the RRSP withdrawal at 40% tax would leave you with $14,657.49 which when added to $4,321.94 would leave you with a grand after tax total of $18,979.44. This is $2,100.39 in savings. Therefore, so long as you don’t violate your overall asset allocation, it makes sense to put as much of the equities into the TFSA as possible and as much of the fixed income in the RRSP as possible. Extrapolate this out for contributions over 30 years and the difference might add up to $30,000 in savings.
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RRSPs: The Definitive Book on Registered Retirement Savings Plans
Preet, in your last example, you mention that RRSP withdrawal marginal rate is the same as at the time of deposit. Isn’t the typical assumption that the marginal rate will be lower during retirement?
Hi MDJ, I would say that the marginal rate in retirement normally is lower, but there are cases where it’s possible to be the same or higher. Maybe I’ll dedicate a separate post on the topic and look at all cases: lower, same and higher marginal rates in retirement. Actually that should prove that holding equities in the TFSA would be best – there’s no downside, but if you happen to have a higher marginal rate than you were expecting in retirement than you could have some upside.
But long answer made short: the typical assumption should be that you will be in a lower marginal tax bracket in retirement, yes.
Thanks for the idea for the next post!
It really depends on when you start investing MDJ. Right now, I’m a graduate student making a pitiful income, so in retirement my tax rate is going to be much much higher than what it is at the moment. The TFSA makes a lot more sense for me than an RRSP until I start a real job.
I guess what it comes down to is estimating (or guessing) what your retirement income will be and what tax bracket you would be in:
If you think your retirement tax bracket will be higher, the TFSA is the better option.
If you think it will be the same, then either the RRSP or the TFSA would be equivalent tax-wise, but since the TFSA is not considered as income, it might make you eligible for higher benefits (OAS and GIS).
If you think you will be in a lower tax bracket in retirement, than the RRSP makes the most sense.
One scenario might be to invest in a TFSA (higher-risk equity investments) starting at age 18 when your tax bracket is low and just keep saving up RRSP contribution room. When you start getting into the higher tax brackets, you can tap the TFSA to max out your RRSP (with lower risk/lower return investments first until you reach you desired asset allocation), and then put the tax refund back into the TFSA. In terms of the RRSP, since you should be switching to safer investments as you approach retirement, Preet’s idea of holding you equity investments in the TFSA, and low risk investments in the RRSP seems like a great plan.
Excellent strategies. I also like Xenko’s idea of maximizing tax savings through the use of TFSA, RRSP and refunds.
Regarding the last strategy (#9), I believe the RRSP is short changed. If you contribute $1,000 into RRSP, the $400 tax refund is after-tax. If you contribute the $400 back to RRSP, you get another $160 tax-refund and so on.
So basically, a $1000 in TSFA is equivalent to $1666.67 in RRSP. (i.e. $1666.67 – 40% = $1000)
Good point, I will include that in my follow up post regarding asset allocation and TFSA/RRSP mix. Thanks FJ!
I’m retired and 61 and had no plan to RIF my RSP till I was forced to. I’m living on CPP and income from some non-sheltered investments. I think I can see an opportunity to start to tax-efficiently collapse the RSP yearly into the TFSA. Then when I am forced to start taking RIF money there will be less to have to take, making it more likely I will be able to keep the tax to a minimum.
Is my thinking on the right track?
You are definitely on the right track CRG. Note that once you are 65, it would make sense to look at converting part of your RRSP to a RRIF account since RRIF income (but not RRSP income) will be eligible for the pension credit. So in other words, if you plan on a partial melting down of your registered assets, you could use RRSP withdrawals until 65 and then RRIF withdrawals from that point on.
Note you must set up the RRIF with periodic monthly withdrawals to qualify for the pension credit – in other words, you won’t qualify for the pension credit if you set up the RRIF and then just take out one annual lump sum. I don’t know why, but them’s the rules! :)
I’m going to be looking at taking out a big lump sum as well to see if the one time "hurt" is worth the tax savings down the road. While you can only shelter $5,000 per year into the TFSA, by taking out a larger lump sum in one year will only cause you "so much" clawback, but may reduce your ongoing clawbacks considerably over time. You can then set up a SWP from the non-registered account to the TFSA yearly to use up the contribution room as it’s created.
Preet
For #8 (non-residents) you have to be careful if the non-resident is making withdrawals from the TFSA while a non-resident, they may be subject to tax in their country of residence. Normally there would be a credit for tax paid, but since there is no tax on the withdrawal from the TFSA there will likely be full domestic tax. It might make more sense to withdraw from your RRSP if you are a non-resident
Unless you retire to Turks and Caicos where there is NO income tax!
But, you are correct in that you should look at the tax regime of your new home country to see the tax treatment of worldwide income (or return of capital). Could be a few snags as you point out.
Preet
Can open TFSA for my children (who are minor and do not have any taxable income) and put money their account on their behalf?
Hi TG, unfortunately you would only be able to do that once they turn 18 as individuals can only earn contribution room starting at age 18. In other words, minor children will not be able to have TFSAs.
Preet,
I have a leveraged investment and believe the TSFA would be better then Universal Life (UL). In short I;
1. Borrowed $150,000 to pay off a 45K mortgage and invest the rest in my RRSP. (105,000)
2. The refund from my RRSP amounts to the 45K I used to pay down the mortgage (marginal tax rate 43%)
3. I invest the complete refund into my RRSP. Effectively now having $150,000 invested and $150,000 owed but no mortgage.
4. I am paying for the loan with an interest free mortgage (hey, back to a mortgage ;-), so small monthly payments.
5. The money I used to put into paying down the mortgage quickly (weekly double-up) can now be invested and hopefully grow faster then the interest of the loan.
6. With the wonders of compounding the future value of 150,000 invested now over 25 years will be substantially larger then if I just made monthly RRSP contributions after paying off my mortgage.
Now the question. I have a UL policy setup to pay off the loan when I retire @ 65. So the over funding I am doing now will provide a pool of tax sheltered money. When I retire I can take out 150,000 and pay off the loan if I choose, or let the policy run and take a loan against it etc.
The question is would I not be better off stuffing the 5000 into a TSFA instead of the UL? I can get a term insurance policy for much cheaper and invest the rest as I want.
Currently the UL policy is hit with a 5% charge on my whole deposit plus a $7.50 charge monthly. They guarantee 4% but likely will produce 5+ %. I could probably do better investing in a cheap bond index fund that has only the MER 0.33 to pay, no sales commissions etc.
The TSFA acts exactly like a UL policy for tax purposes and can be handed to the kids when we both go. I can take out the 150,000 if I want to and unlike the UL the whole pot of money is 100% tax free!
I also prefer to do the investing and have more visibility then watching the Life Insurance company do it and widdle away with service charges…
GL
Hi GL, sorry for the delayed response, I’m on vacation so I’m in lazy mode! :)
Before getting to the strategy you indicated, I will address your question first. If you were only using the UL policy to build up tax-sheltered investments, then your insurance coverage was probably dictated by the amount of deposits you wanted to make without exceeding the MTAR line. So first things first, you need to figure out how much insurance you actually need and more often than not you will only end up needing term up until the time you retire (but best to get a proper analysis done to be on the safe side).
That being the case, and you only need to shelter $5,000 per year the TFSA is your ticket for all the reasons you mentioned – and good for you for thinking of it! :) It’s a no-brainer comparing the two, the TFSA is much better than building up the cash reserve and then pledging it as collateral for a loan through the UL (assuming you have no need for insurance later on in life).
Now my questions for you about the first part of your comment:
1. Assuming you are in Ontario, if your marginal tax rate was 43%, then the maximum possible tax refund you would get is $36,641 on a $105,000 RRSP contribution. Therefore you would have $141,641 invested instead of $150,000.
2. Question, did you get an interest-free loan through work? If so, there is a taxable benefit which must be added to your income at the CRA’s prescribed interest rate multiplied by the loan balance. (and if you meant tax-deductible interest on the loan – then actually you cannot deduct the interest since the loan proceeds went to the RRSP).
Let me know if I’m misinterpreting your situation, otherwise if I’m not then there is some corrections to apply to the math to determine the true benefit.
Thanks,
Preet
Hi Preet,
I hope you had a good and restful vacation. Thanks for the reply. I went back and looked at my post and found the error in my wording. I’ll email you this reply but if you’d like to keep the thread going I can cut and paste the important parts into a posted reply to your website so others can benefit.
I meant to say interest ONLY loan. Not interest free. I am paying the minimum interest only payments on the 150,000 mortgage I now have. It is through a broker and I got a 5 year 5.70 rate.
The idea is to allow the RRSP investment to grow now, fully and through compounding to amount to (hopefully) much more then the 150K loan.
Using a UL policy I will build up an amount large enough to pay off (if I choose to) the 150K loan when I retire. A tax free withdrawal from the UL that is essentially a refund of my policy payments. I would also have a cash value left over to pay any tax hit when the RRSP goes from me, to my wife, then onto the kids where the estate tax will hit. So whatever is left over in the RRSP and gets taxed when both parents pass onto the kids will be at least partly covered with the funds in the UL.
I need life insurance now and up to retirement. I got a 750K policy. I would hope to not need life insurance into retirement and instead would use its value more for estate planning. I.E. paying for the tax hit on the RRSP investment income with the funds in the UL. (for the kids)
I live in Ontario. My marginal tax rate is 46.3 I believe. I deposit 105k now and get a refund. I only claim what is needed to get a refund of 24K. The 24k goes into the RRSP completely so next year using the unclaimed amount (from the 105k) plus the new deposit (24k) get back roughly the same amount again and end up with close to 150K in my RRSP.
This leveraged investment plan has taken me from having a small RRSP to 150K now. I had a mortgage of 46K which is now 150K. I make minimum payments on the mortgage loan and instead stuff money into a UL policy that gives me the life insurance I need (anyhow) and an investment that will grow tax free outside the RRSP that can pay off the 150K loan at retirement and provide an estate plan portion for the kids to take care of taxes on the future (25 years) value of the RRSP.
My question boils down to how is it best to grown the funds to pay off the 150k loan? Use the UL policy or use a TSFA. The UL is not the best investment vehicle, but until now was the ONLY one that worked. With the TSFA comes a new way to invest and grow tax free the funds to both, pay off the loan at retirement AND pass down the money tax free to my wife then kids. I assume I can invest this money in bonds etc and do better then the life insurance company.
I hope I made things clearer. Please let me know if you have a question on anything I just wrote.
GL
Note to readers: answer was provided by email to GL.
Hi Preet,
I’m very curious about the conversation on dumping GL’s money into RRSPs instead of mortgage payments. It’s an interesting concept but wouldn’t taking out a long mortgage (say 30 years) and making minimum payments on it while depositing the surplus money into RRSPs, high dividend yeilding stocks, or growth stocks have a similar effect?
Freezie
Hi Preet.
As far as I can tell (CCH tax book), any withdrawal from a RRIF would qualify for the pension income credit and pension income splitting. In your 3 March reply to CRG you say it’s minimums only. Do you mind providing back-up for that?
Thanks.
Hi EROOM, thanks for your question.
Actually, I never mentioned that it should be the minimum amount, but rather that the withdrawals need to be structured as regularly occuring withdrawals as opposed to lump sum withdrawals. The source of my information was a phone conversation with a tax officer at the CRA. They made it very clear that the withdrawals need to be structured like annuitized income (just like you would receive income from a pension) in order to be treated as such.
However, the CRA will be the first to tell you that the last word on any subject will be the interpretation of the ITA and any IT’s that are issued (Income Tax Act and Interpretation Bulletins respectively). (i.e. not ME and not the CCH tax book). I’ll see if I can dig up the section of the ITA or an IT that has it in print.
Hi Preet.
It’s a fairly common strategy to convert some RRSP to RRIF at age 65 and draw $2,000 per year until age 71 ($14,000 in total) to claim the credit if you have no other qualifying pension income. Although that seems to meet the definition of periodic, I’m not aware that is a requirement.
Official CRA position is often difficult to come across. The following may be helpful; it’s from a former bulletin IT-517R which CRA archived, so it’s not on their site anymore. But it’s still in the CCH software. This is also the same wording CCH uses in their current tax preparation material.
See 2(a)(iii)
2. An individual who has attained the age of 65 years before the end of the year is entitled to a pension tax credit determined by multiplying the lowest Part I tax rate percentage (currently set at 17%) by the lesser of $1,000 and the individual’s “pension income” received in the year. Subject to ¶8 below, subsection 118(7) defines “pension income” received by an individual in a taxation year as the sum of
(a) the total of all amounts included in computing income for the year each of which is
(i) a payment in respect of a life annuity out of or under a superannuation or pension plan, including a foreign plan;
(ii) an annuity payment under a registered retirement savings plan (RRSP), under an “amended plan” as referred to in subsection 146(12), or under an annuity in respect of which an amount is included in income under paragraph 56(1)(d.2) (see comments in ¶3 below);
(iii) a payment out of or under a registered retirement income fund (RRIF), or under an “amended fund” as referred to in subsection 146.3(11);
(iv) an annuity payment under a deferred profit sharing plan (DPSP) or under a “revoked plan” as referred to in subsection 147(15);
(v) an instalment payment out of a DPSP as described in subparagraph 147(2)(k)(v) (see ¶10 below); or
(vi) the excess of an annuity payment included in income under paragraph 56(1)(d) over its capital element as determined under paragraph 60(a); and
(b) amounts accrued on certain life insurance policies and annuities and included in income under section 12.2 or former paragraph 56(1)(d.1).
Hi EROOM – thanks for posting that info – much appreciated. It would seem to indicate that the bulletin is out of date since it references the old limit of $1000 versus the current $2000, but nonetheless the final interpretation will always be that of what is in writing with the CRA. Personally, from hearing from the tax officer – he made it extremely clear the RRIF income had to be SWP’d out. Based on the information you have provided, the next time someone is contemplating this I would call the CRA again for guidance and ask for them to point me to the material suggesting the definite interpretation. If you have it in writing, that is your best alternative.
I think what you have posted (in it’s up to date form) suggests that lump sums would indeed qualify. I suppose the auditor would have the final say? :) For readers, I would suggest that it’s best to discuss this with a qualified professional advisor for your own situation before acting on this information (or any information on this site).
Hi Preet, I’m trying to get my mind around strategy 1. When you say convert your class fund into the TFSA, are you rebuying the class version or the Trust version? Then when your ACB reaches 0 in the non-reg account, are you not then forced to declare all future distributions as a capital gain? Basically, I think I’m missing the benefit. Can you explain further?
Hi Tarun, thanks for your questions. Inside the TFSA, there is no reason to buy the class structure so you would buy the cheaper trust version. In the non-reg account, yes: once the ACB is ground down to zero, all future “ROC” distributions are now capital gains distributions. This strategy makes sense if the savings on fees between the class and trust version are large enough to offset any extra taxes owing – which would require a detailed analysis as everyone’s situation and portfolio constitutions are obviously different. For example, if the savings are 25bps per year and it takes 20 years to grind down the ACB (just an example), and in 20 years the investor is in a very low tax bracket (compared to now) then it would’ve made sense as the annual savings in fees would grow over time and by the time the ACB on the non-reg class funds reaches zero, the tax on the capital gains distributions may be quite low.
The TFSA only protects your income against tax by the Feds as far as I can figure out so you are still liable for any Provincial tax?
dear mr. preet
reg rrsp even if our MTR goes down by 10% in later years. even then early withdrawls will be harmful due to panelty portion 10%…. for mid income families in age group of 30-40 in my opinion its not a good idea of killing today(age 35) contributing in RRSP( other then 1st time HBP), for tomorrom(age 65). so i think that RRSp is best for high income people like iT prof.teachers,nurses,politicians,media, dr., lawyers etc. who really dont want any money before retirement.
i support TFSA till i get close to age 50 with less debts and more assets.how right im??