By Jonathan Chevreau
Financial Independence Hub
Here’s my latest column from the print edition of MoneySense magazine, written right after the federal budget: Get the new TFSA limit to work for you.
Click on the link for details, but in a nutshell — and has been extensively reported in the media, such as this piece by Gordon Pape (subscribers only) — there’s no reason why you can’t add another $4,500 to your Tax Free Savings Account right now, in addition to $5,500 you may have contributed anytime on or after Jan. 1, 2015. (Note to American readers: the TFSA is the equivalent of Roth IRAs, providing no upfront tax deductions but which let you eventually withdraw money tax-free in Retirement or for other purposes).
That means a whopping $20,000 per couple. Now while Liberal Leader Justin Trudeau seems to think only “rich” people have that kind of money available, the fact is that many hard-working middle class people have been saving and investing for the better part of two or three decades, and built up substantial non-registered or “taxable” portfolios. Even though they may have paid income tax to acquire the capital in the first place, over those decades they have been paying annual taxes on interest, dividends and (often) capital gains generated by that capital.
As the column points out, those who have built such “open” portfolios don’t have to use new cash to put $10,000 per annum into their TFSAs. They merely have to start transferring their non-registered securities into their TFSAs. This is called a “transfer-in-kind” but as I have pointed out here and elsewhere (see for example last Friday’s piece in the Financial Post: The Million-Dollar Tax Problem), the tax rules are complex. In a blog I wrote this week for Motley Fool Canada, we also look at How to make an extra TFSA contribution if you don’t have $4,500 lying around.
Ideally you find a stock, ETF or mutual fund that is more or less trading at the price you originally purchased it. Say for example you bought 100 shares of Bank Stock A two years ago at $50/share and the stock is still trading at that level. You can ask your brokerage to “transfer-in-kind” 90 shares (worth $4,500) into your TFSA and that would be the end of it. Going forward the 90 shares will no longer generate taxable income reported on T3s and T5s next tax season early in 2016. (Remember, the extended tax-filing deadline for calendar 2014 is today!). The ten remaining shares that stay in your non-registered portfolio would of course continue to generate a bit of tax liability for you but it will be 10% of what it was. Next January, you could move them too into your TFSA.
Tricky tax calculations
Where it gets tricky is where there are capital gains tax to consider. In my original blog on this subject, I oversimplified and suggested finding “pairs of securities where the profits on one offset the loss on the other.” It’s a bit more complicated than that and if you have any reservations at all, I suggest consulting with your accountant or a tax professional.
From what I understand in discussions with experts like CIBC Wealth’s Jamie Golombek, if you transfer-in-kind a security that has appreciated since you bought it, the Canada Revenue Agency will consider that a “deemed disposition.” By making the transfer, you are crystallizing a capital gain that otherwise could have continued to be a paper profit you could have let ride. (ironic, isn’t it, that in order to take advantage of the TFSA, you may have to accelerate receipt of capital gains?)
But let’s say you transfer only $2,250 worth of a winning security and can find another $2,250 that are the proceeds of a losing security. Perhaps the first stock had a capital gain of $1,000 and the second an offsetting loss of $1,000. This should be a tax-neutral transfer except for one complication: the CRA won’t let you declare a loss by transferring-in-kind the losing security. Therefore, you’re going to have to crystallize the loss by selling the losing position while it’s still in your non-registered portfolio. Once that’s done, THEN you can transfer the resulting cash into your TFSA.
Once it’s inside the TFSA, you could in theory repurchase the same security but because of another arcane provision you should wait at least 30 days before doing so. That’s because of the CRA’s superficial loss rules. If you’re transferring ETFs, you might be able to sell the one while in the taxable portfolio, and purchase something very similar once it’s inside the TFSA. But that’s a topic for another day.
It’s worth it
I apologize for the complexity of this but the bottom line is that it’s worth it. Remember, the original name of the TFSA was the Tax-PREPAID saving plan. You paid the tax on the capital in the first place and in my view are entitled going forward to benefit from tax-free investment income generated by that capital. The TFSA merely eliminates double taxation. (or triple, if you want to consider the GST, HST or other consumption taxes that kick in when you eventually purchase a good or service with the funds.)
RRSPs and RRIFs another source of funds
Another source of funds for these super sized TFSA contributions are RRSPs and RRIFs. As with the above example involving taxable accounts, it will be necessary to pay tax when you withdraw money from RRSPs or RRIFs. But again, once you take the tax hit up front and get it into the TFSA, it will be well worth it for the subsequent tax-free flow of income generated by your growing TFSA.
Certainly, Hub readers welcome the opportunity to use the TFSA to its maximum potential. See last Friday’s blog on how many readers are embracing the new higher limits.