Capital Gains Tax advantage of the TFSA

March 1, 2016

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There are tax benefits to the Tax-Free Savings Account (TFSA) when assessing future taxation on capital gains on investments.

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. And 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.

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Death and RRSP Taxes When you die (with no remaining spousal roll-over) your RRSP wealth is considered “cashed out” placing you up to a near-50% bracket, reducing this portion of your nest egg up to about 50% of your RRSP.

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.

“Insufficient facts always invite danger, Captain.” (Spock from Star Trek)

In reality, what occurs with most RRSPs Essentially your tax deduction over the years is only a “deferred tax deduction” if the government gets to take a portion of your tax refunds back with all the accrued growth of your investments also. This is the case often when people do not outlive their RRSP wealth.

What capital gains advantage does the TFSA offer? Rather than paying tax on up to half of your investment profit, the entire amount is yours to keep. This is of particular interest to those who invest in stocks and equity funds.

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.

Changes affecting TFSA contribution:

  • The new Liberal government announced that they would reduce the contribution amount for TFSA and re-introduce indexing to inflation for the annual limit. However, they also said they would still 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 1st, 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.

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.

Talk to your advisor about the use of TFSAs to see if they are applicable to your investment planning.

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