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Is Your TFSA Doing Enough?

Reach further with your Tax-Free Savings Account.

Your Tax-Free Savings Account, sure it's great as an emergency fund or a solid option to save for your next vacation. But reach a little further. You'll find it can do much more. Surveys indicate while less than half of Canadians have started a TFSA, even fewer have plans for how they'll use their account. Many are missing out on the powerful financial tool a TFSA is becoming, not only as a short-term savings vehicle, but also in tax planning and investing.

More valuable every year

For 2019 the TFSA annual contribution limit is $6,000. This means you can now have up to $63,500 of contributions in your plan in 2019. For a couple, that's $127,000.

With new contribution room added automatically each year by the government, the total amount you can work with tax-free will continue to grow. Future changes in the annual contribution limit will have to be legislated and are at the government's discretion.

What benefits are you overlooking?

It's time to think about your TFSA as a key part of your financial toolkit. As contribution room continues to build, putting the right TFSA strategies in place becomes essential.

What you do will depend on factors like your age, income, family situation and objectives. Here are a few ideas to pay attention to.

1. Keep more of your income, year-in and year-out

An RRSP can be a terrific tax-saver, but not always. Why? How much you can put away is based on earned income which isn't always predictable.

Perhaps in your profession your earnings swing up and down from year-to-year. What if you choose to take time away from work, or are forced to due to illness or unemployment?

If you're not earning an income, you can't create contribution room for your RRSP. But you still may be generating cash from other sources like your investment portfolio, a gift or an inheritance. That's money you want to protect from tax.

With a TFSA, contribution room is added annually independent of your earnings. So when your RRSP comes up short you can still use your TFSA to shelter that extra income.

2. Boost your retirement savings

With RRSPs you can't always save as much as you would like. If you're already maximizing your contributions, belong to a pension plan or can no longer contribute to an RRSP, a TFSA can add much needed lift to your retirement savings.

Stretch your shelter. If you're forced to leave part of your income each year in a non-registered investment account because you've reached your RRSP limit, paying extra tax is frustrating. That's where a TFSA can help. Redirect those surpluses to your TFSA plan instead where they can grow tax-free.

Here's the difference it makes. Say you're in a 40% tax-bracket and can save an extra $5,500 a year. You invest those funds at 5%. Assuming the investment you choose is taxed at your marginal rate, in a regular investment account those annual savings will build to more than $152,000 over 20 years. But by making TFSA contributions instead, your balance would grow to nearly $191,000 – almost $40,000 more.

If you're a high income earner RRSP limits can especially affect you. The extra growth a TFSA can deliver over putting dollars into a taxable account can help you replace enough of your working income to maintain your lifestyle in retirement, a difficult task for RRSPs and pensions alone to manage.

Make up lost contribution room. It's clear a company pension plan is a valuable asset. But, each year that plan requires a pension adjustment that reduces your RRSP contribution room. Being able to protect savings annually in a TFSA helps make up for what you lose.

Continue tax-savings even in retirement. From the moment you're eligible to contribute to an RRSP, the clock starts ticking on how long you can add money to your plan. When you turn 71, time's up. You won't be able to make any further contributions.

But because you can hold a TFSA indefinitely you can continue to put money away tax-free even after your days of contributing to your RRSP are done.

That can be important in letting you better manage cash flow from your RRIF. Mandatory RRIF withdrawals can create a situation where you don't always need the income you are required to take. The TFSA gives a home to those excess funds where they can remain tax-sheltered.

Reduce risk of the OAS clawback. If you're receiving Old Age Security payments and you expect your income to exceed $70,954 this year, you're at risk for the OAS clawback. Shifting some of your assets, and investment earnings, from a non-registered investment account to a TFSA can reduce your net income and help you avoid losing some, or all, of your benefit.

3. Split income another way

Done carefully, income splitting strategies take advantage of the differences in tax brackets between spouses or other family members to lower the total amount of income tax a household pays. A spousal RRSP and pension sharing are proven income splitting options. So is the TFSA.

While the rules say you can't contribute directly to a family member's TFSA, you can give them money to add to their plan.

Rather than holding these funds in your taxable account, future investment income is instead earned tax-sheltered in your spouse's or adult child's TFSA. A household can have more tax-free income regardless of whose funds are invested. Over time you can shift a significant amount of capital and accumulated growth to lower-income family members and save tax.

Keep in mind that transferring funds means losing control over those contributions. You might even have to sell assets to free up the cash to give, which could have tax consequences. Consult your financial advisor before taking this step.

4. Transfer your wealth

As adult family members build contribution room, the TFSA becomes a tool to gradually transfer wealth to your loved ones when they might need it the most.

As with income splitting, funding family member TFSA contributions is the key, as adults start to accumulate contribution room at age 18. For your adult children and grandchildren the funds you provide for their TFSA becomes a tax-free source for a down payment on a home, funding higher education or starting a business.

Beyond helping out the younger generation sooner, by holding on to fewer assets and simplifying your estate, you'll leave less stress and expense for your family in settling your estate later on. And by gifting assets you can afford to live without, you'll likely reduce your income base and pay less tax along the way.

Remember, once you give assets they're no longer yours. You have no control over how those funds are used. Make sure you are comfortable with this possibility, or, ask your advisor about wealth transfer strategies that allow you to retain ownership while benefiting others.

RRSP or TFSA: Which Should You Dip Into for a Home, School?

Should you tap your RRSP to buy your first home or to pick up on your education? Or is using your TFSA the smarter way to pay?

The Home Buyers' Plan and Lifelong Learning Plan allow you to unlock RRSP funds to help with these priorities. But they can also be restrictive and full of complex rules. Under the HBP, for example, the plan holder must repay some of the borrowed funds to their RRSP each year and have it all returned over 15 years. Once those funds are withdrawn that RRSP contribution room can't be restored.

On the other hand, with a TFSA the money never has to be replaced. The amount you withdraw is added to future contribution room so you don't have to sacrifice future tax-savings.

Some experts advocate a best-of-both-worlds approach, using funds from your TFSA to first contribute to your RRSP to generate a tax deduction, and then turn to the government programs. Is it a wise move? Not always. Ask your advisor what will work best for you.

No matter which ideas you consider for your TFSA, it's important to understand how those strategies work in your broader financial plan. How can your RRSP and TFSA team up? Is one better for you than the other? Where does your investment account or an RESP come in? Only when all of the pieces fit properly can you minimize tax and stay on the path to achieving your goals.

Ask you BlueShore Financial financial advisor for a full review of your tax-saving options. They'll help you make sure your TFSA is doing enough.

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