TFSAs, RRSPs, Death and Taxes

January 1, 2016

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There are certain tax benefits to the Tax-Free Savings Account (TFSA) when assessing future taxation. Let’s compare RRSPs and TFSAs. Bear in mind that there have been some changes affecting TFSA planning:

The TFSA has now been reverted back to $5,500 from $10,000 contribution per year. Here are the facts:

  • The new Liberal government announced that they would reduce the contribution amount for TFSA and re-introduce indexing to inflation for the annual limit. The upside is that they also said they will allow Canadians to keep the full $10,000 of contribution room for 2015, whether they used it or not.
  • Effectively they “grandfathered” the $10,000 TFSA limit for 2015 meaning that there is really no urgency to rush out and get that $10,000 contributed for 2015. That contribution room will carry forward indefinitely.
  • The total contribution amount for January 1, 2016, for a Canadian who has never contributed to a TFSA will be $46,500 if the individual was 18 or older in 2009 when the TFSA was created.

RRSPs miss any capital gains taxation benefits. Equity funds earning capital gains in a non-registered account get a benefit of being only 50% exposed to taxation. In non-registered equity investments (not in an RRSP or TFSA for e.g.), any gains can be offset by capital losses. Not so with RRSPs. All capital gains—in fact all income earned in an RRSP and RRIF are taxed at your marginal tax rate when taken out. And bear in mind that capital losses cannot be claimed with an RRSP.

What capital gains advantage does the TFSA offer? Rather than paying tax on up to half of your initial principal investments plus any profit, when withdrawing from an RRSP, the entire amount is yours to keep in a TFSA—on any investment including capital gains. This is of particular interest to those who invest in stocks and/or equity funds. As an investor, imagine being able to take all of your money out as you please from a TFSA, now or in retirement without being taxed.

What about capital losses? As TFSA capital gains are not taxed within your TFSA, tax losses occurring in an investment held within a TFSA cannot apply against other capital gains.

One might agree that, “Insufficient facts always invite danger, Captain.” (Spock, Star Trek)

How does a TFSA contribution affect my RRSP? Your TFSA contribution does not affect your annual RRSP contribution limit. The difference between the TFSA and the RRSP is that TFSA contributions are not tax-deductible and income earned in your TFSA whether compound interest, other investment income or gains, is tax-free when withdrawn.

Estate planning and the TFSA Individuals can name surviving spouses and partners as successor account holders, ensuring the tax-free status of a TFSA will continue after death. Note: The TFSA allows funds to be rolled over to the successor annuitant, up to Dec. 31 of the year following the year of an annuitant’s death. Form RC240 must be completed for this to happen.

Small fortunes and the RRSP The following amounts could accrue to a person who invests a small amount of money over time. One person alone, could accumulate a whopping $301,478—the amount in an RRSP at age 65 if a person started contributing $2,000 every year from age 25 (assuming five per cent compound annual growth and 1.5 percent inflation).

Death and RRSP Taxes When you die (with no remaining spousal rollover) your RRSP wealth is considered “cashed out” placing you up to a near-50% tax bracket, reducing this portion of your nest egg—which may be earmarked for your heirs—to about 50% of your RRSP.

Essentially your tax deduction over the years is really only a “deferred tax deduction” if the government gets to take a portion of your contributions back with all the accrued growth of your investments also. This is still the case when people do not outlive their RRSP wealth. True, the government pays you a tax refund every year that you contribute your hard-earned money. In effect, you have agreed to allow Canada Revenue Agency (CRA) to swap your RRSP/RRIF wealth—including any capital gains on stocks or equity funds—as a form of reimbursement for your annual tax refund over the years. So for some the RRSP may not be the preferred route of investing.

How can a good financial plan help? To minimize the government take-back of taxes on money left in your RRSP/RRIFs in your estate after your death, there are some important planning tactics that you can use:

  • Consider balancing your RRSP contributions with TFSA contributions in the future. TFSAs are not taxed when money is withdrawn or in the estate
  • Consider mixing TFSAs and perhaps non-registered investments, into your retirement savings mix.
  • If you have substantial wealth held in RRSPs there is an estate planning tactic that uses a permanent life insurance plan to mitigate the taxes payable to the government. From a small percentage of the RRSP holdings per annum you pay premiums on a life insurance policy with an equivalent face value of up to half of the value of your RRSP/RRIF holdings. When you die the insurer pays a tax-free benefit to your estate or your beneficiaries free of government probate or estate administration tax.
  • You may also consider purchasing a joint last-to-die life insurance policy to compensate for the taxation in your final estate. This works well for married partners. When both spouses die the insurer pays a tax-free benefit to your estate or your beneficiaries.

Talk to your advisor about combining RRSPs, TFSAs and life insurance to maximize your tax planning.

Source: Adviceon | CBC | Source: Statcan

 

 

 

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