The tax-free savings account (“TFSA”), while important to many Canadians, will be seen as relatively insignificant to others. But it seems that this account might be worked into something more significant.
This brief article will outline a couple of strategies that might help optimize this tax shelter.
It will be recalled that the TFSA, in simplistic terms, allows one to contribute to this special account without incurring any taxes on interest, dividends or capital gains that this account earns, and it does not attract any taxes when money is withdrawn. This concept is similar to the Roth IRA account in the United States, except that the TFSA has no restrictions on withdrawals and, assuming no amount in excess of the $5,000 yearly contribution is made, then any amount withdrawn (including earnings) can be put back into it.
In other words, when you withdraw money from the account, the “re-contribution” room available gets “set” at the amount of the withdrawal. And of course, on a yearly basis, one has an additional contribution room of $5,000. With reference to withdrawals, it should be noted that you must wait until the following year to replenish the account.
At the outset, at least three choices present themselves: (1) opening an account at a bank, (2) opening an investment account through a full service brokerage, or (3) opening an online brokerage firm account.
Because the initial contribution amount is modest, the bank option will readily present itself. That is, there are minimal opening, withdrawal or account closing fees and no ongoing administration fees, but of course, one is restricted to such things as term deposits or mutual funds.
While an account with a full-service brokerage firm will provide direct assess to stocks and be more flexible than the TFSA bank account, there will be opening, annual administration and withdrawal costs to factor in. But let us consider such an account beyond just the caution about administration and other costs.
Contributions “in Kind”
Rather than putting $5,000 of cash into TFSA account on an annual basis, one can opt to transfer securities into the account. So, for example, an income producing stock that one has outside of a registered plan (RRSP or RIF), having a value of $5,000 at the time of transfer, can be put into the TFSA account.
Obviously, if this stock had an accrued gain because it was purchased for less than its fair market value at the time of the transfer, then there would be a capital gain, and tax would have to be paid in the year of transfer. And what if this stock was originally acquired at a higher price?
If the stock that you plan to transfer into the TFSA was acquired at a cost higher than the current value of $5,000, and if this transfer were to be done directly, then a tax loss would be denied, as this would be seen as coming under the superficial loss rules.
But the superficial loss rules can be bypassed by selling this stock, putting the $5,000 in one’s TFSA and then, 30 days later, buying the same stock and making that purchase part of the TFSA portfolio. Obviously then, this two-step transfer would be done only if one had a loss and wished to claim a capital loss. The swap may be a different kettle of fish, or so it seems.
With RRSPs, the swap is well established, if not well known. So, for example, a person has a stock as an investment outside of any registered plan and also has $5,000 cash inside an RRSP. One could do a swap to bring the stock into the RRSP and move the $5,000 cash out, thereby freeing up that cash amount for other uses.
Will a swap also be permitted with TFSAs? If so, then this may be one of the vehicles used to work the TFSA into something more significant (or so the theory goes). Let’s say a person buys a speculative stock within the TFSA for, say, the first yearly maximum permitted ($5,000) and this stock, in short order, grows (assuming stocks will again grow) into having a value of $20,000. (As you see, one can be extremely optimistic and even wishful in hypotheticals.) With this rise in value, the TFSA holder freezes the TFSA gain by withdrawing the stock from his TFSA and leaving the TFSA with a nil balance, but with re-contribution room of $20,000.
Now, it was originally touted that, at any time, one could put back into your TFSA any amount withdrawn, but it may be that January 1 of the new year is the re-contribution date up to maximum contribution room one has established. In the hypothetical, come January of the new year, the TFSA holder can replenish the TFSA account up to a maximum of $20,000. Now on this swap, the TFSA holder did lose the potential for gain from the time he withdrew his speculative stock to the date of re-contribution (January 1 of the new year.)
But if one adds a further wrinkle to the above scenario, one may be able to maximize the TFSA benefit and avoid the risk of reduction in value to the TFSA. Let’s continue with the same fictional situation. The TFSA containing the speculative stock rises to $20,000, but rather than sell it and mark one’s new upper limit, one could merely swap it for an equal amount of cash, so that $20,000 cash comes into the account and the stockholder remains the holder of the stock outside of the TFSA and, in that way, retains ownership with the possibility of future gains, but, of course, as taxable gains.
Just a final word: The Canada Revenue Agency is the initial interpreter of what is permitted and what is not permitted, and can change its mind on policy and guidelines. That should be borne in mind by those who wish to become bullish in their approach with this account.