Are you one of the six million Canadians who have opened a tax free savings account (TFSA)?
Have you ever wondered about the real purpose of these accounts? You’re not alone. Millions of Canadians are unaware of the potential windfall that former finance minister Jim Flaherty handed them in 2009 when he introduced TFSAs.
TSFAs were introduced to encourage Canadians to invest in Canada. It was thought at the time to be a saviour for Canada’s investment-starved technology sector.
TSFAs are government-regulated savings accounts that carry special rights. The limit starting in 2009 was $5,000. The government then changed the annual TSFA contribution limit to $5,500 for two years, then to $10,000 for one year and now back to $5,500 for the next two years. It’s starting to add up. An adult can have amassed $52,000 if they contributed the maximum allowed each year – and that’s a considerable sum.
What’s so good about this opportunity?
You can invest your TSFA in almost anything and you don’t pay a penny in taxes on capital gains. If you invested this capital and made a $100,000 gain, you would pay no tax on that gain. If you drew down that capital gain and paid yourself an income, you would pay no income tax on that revenue.
So why don’t Canadians use TSFAs to invest in high-risk, high-return ventures?
That’s a very good question, since there’s no doubt the Canadian economy needs this money to be more productive. In the nine years since the introduction of the TSFA program, more than $90 billion has accumulated in these plans. Regrettably, almost all of this capital is languishing in Guaranteed Investment Certificate (GIC) type accounts earning one to two per cent annual returns.
The pitiful reality is Canadians aren’t taking advantage of this potential windfall. Canadians have been convinced that TSFAs can’t be self-directed; that the only investment options are bank-sponsored funds that, frankly, aren’t doing investors any good or helping the technology sector, which would help our economy.
The TFSA program is massively misunderstood. Let me give you an example:
About a year ago, I was travelling with an old friend. We had a good chance to talk without distractions. He mentioned he and his wife both had TFSAs and that he had just moved all of his TFSA money from one bank to another for a better interest rate.
Later, he told that me a mutual friend had recently bought controlling interest in a silver mine and the prospects were promising. He said he’d bought $10,000 worth of shares in the company. I asked what the shares might rise to if the assay work proved successful. He told me he’d paid 20 cents a share and they could rise to $2, a tidy profit.
I asked if he’d purchased the shares in his TFSA account. His reply astonished me.
“You can’t do that!” he said.
“Oh yes you can,” I replied. “And not only can you, you should do that.”
There was about five minutes of deadly silence. I could tell his thoughts ran something like this: “What the heck, my financial adviser didn’t tell me this.”
I explained the tax implication of a profit scenario in which $10,000 invested at 20 cents per share yields $100,000 if those shares sell for $2 each, showing a profit of $90,000.
- The normal tax on that profit would be as much as $45,000.
- If you could qualify this as a capital gain, then only half of the profit (or $45,000) would be taxed. That still means paying $20,000 to $22,500 in tax.
- But if he had bought the shares through his TFSA, the tax payable would be zero.
When you get your next TFSA statement, take a good look at it and consider the following:
- Your financial adviser’s interests may not align with yours. They may wish to place your TFSA money in financial products that benefit them the most.
- Start thinking of this TFSA money as your equity fund and use it for higher-risk investments. Remember, if the risk works, the reward is tax free.
- Consider investing in our country’s future. If Canadians don’t believe in their own technological future, nobody else will. We have some of the sharpest brains inventing groundbreaking technology. It will wither on the vine if we don’t invest in it. By helping out, we can create successful businesses with jobs and growth potential.
Canadians need to do their homework about the potential of their TFSAs. It’s their money.
Joe Batty is an accountant with a specialty in new asset management. Joe has more than 40 years of experience in finance and accounting.
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THOUGHT FOR RETIRED PEOPLE
Assume you only withdraw what you need from a RIF; your estate will pay personal income tax on the year of death along with tax on any other income that year. On the other hand, if a retired person withdrew the max amount allowed for TFSA, sure it’s possible that person would pay more income tax in each of those years but when that person dies the value of the TFSA is transferred tax free to that person’s beneficiaries. Idea here is for RIF funds to end up in TFSA if at all possible prior to death. An older person who makes more in the RIF than they withdraw should consider moving assets (in kind) from the RIF to the TFSA. This will significantly reduce taxes paid on a liquidated RIF upon death. I think most older people have no knowledge of their coming tax bill… sad but true
My comments (posted April 2) applies only to retired person (single) as RIF allows for transfer in kind to surviving spouse and a couple other situations. I believe the industry does not promote the TFSA advantage for fear that some people will move away from managed accounts into self directed. In other words, maintain the status quo and the fees and trailers fees, fees from third parties continue a cash cow for some managers. This is the disturbing aspect of this as the TFSA cumulative tax saving advantage is ever increasing as we go forward for a variety of reasons mentioned in your article.