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Posts Tagged ‘swap’

TFSA – To Swap or Not to Swap

September 3rd, 2010

Should Swaps be banned completely?

This is one of the hot topics of discussion as regards TFSA contributions.   As soon as some innovation is introduced, there are those who don’t know much about it, those who educate themselves thoroughly to try and optimize the situation, and then, there are those who try to take advantage of a good thing.   It is this last group that the Government wishes to keep in check and thus implements new rules to ensure that no-one benefits to an unfair extent over others just by manipulating “loopholes” in the system.

One such area is that of swaps.   In-kind contributions are allowed into a TFSA.  Non-registered investments like stocks can be put in and if they appreciate in value and are withdrawn, then that creates extra contribution room to the tune of the value upon withdrawal.  A swap is slightly different.  It involves the exchange of equity or cash and equity of equal value.  For instance, if one had $4,000 in the TFSA and needed the money, one could put $4,000 of stocks into the account and free up $4,000 in cash to spend.  This makes swaps a useful planning strategy as they enable an investor to increase contribution room under the right circumstances.

A TFSA swap does not involve withdrawal and contribution, only acquisition and disposition of property at fair market value.

So why ban swaps?

What the Department of Finance is trying to crack down on is what they term as “the use of inappropriate transactions to draw excessive benefits” from the TFSA.   This amendment covers:

a) Purposeful excessive contributions to TFSAs

b) Holding non-qualified investments in TFSAs, and,

c) Swap transactions.

This is how the Department of Finance explains its stand: they say that swap transactions, which are not treated as withdrawal and re-contribution, are treated instead, as straightforward purchase and sale.  They are also called asset transfer transactions.   Subject to the application of prevalent anti-avoidance rules in the Income Tax Act, if these transfers are effected frequently with the objective of exploiting small changes in asset value, this is just a shift in value from one account to another with no real intention of disposing of the asset.

It has been studied how frequent swaps between an RRSP and a TFSA can slowly but surely transfer funds from the former to the latter and then be withdrawn tax-free.  But is a complete ban on swaps the solution to this problem?  The jury is surely divided!

The fact is, even in the absence of swaps, investors who wish to be crafty still have another option open to them.   They can sell an asset in one account and buy it in another.   Though this is a more expensive route, it is still available for those who wish to shift value into a TFSA from another account.

Maybe the Department of Finance does not wish to provide additional measures to investors to overuse the system.   That would be like encouraging dishonesty.   People are divided in their views on this topic of debate.  Maybe more stringent rules could have been laid down as regards swaps rather than banning the whole concept.   If used in moderation, it adds flexibility to the whole idea of TFSAs, and encourages savings further, in a sense.  It also helps deal with people’s negative view of the $5,000 ceiling for annual contributions.   A closer monitoring of these transactions in addition to more stringent rules could certainly have done the trick to clamp down on misuse of the system.

If you want to tell us what you think or register an opinion, send your comments below.

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How To Maximize your Tax Free Savings Account

April 8th, 2010

How To Maximize your Tax Free Savings Account

It is one thing to be provided with a gift, and quite another to learn how to make the most use of it.  A common complaint is the dearth of cash, especially after the holiday season.  Ottawa’s answer to this was the Tax Free Savings Plan, introduced in the 2008 federal budget, effective from 2nd January 2009. Many are aware of this financial innovation, yet, not everyone has the savvy to optimize it. Studies actually bear this out. It is advisable to educate oneself in order to benefit to the greatest extent possible from the TFSA.

So many thousands of people signed up for this account since October 2008.  Home prices fell, and so did the stock markets, bringing RRSP values down too.  Canadians seem to be realizing the importance of saving money for a rainy day as well as personal splurges. It has been predicted that Canadians would sock away up to US $ 115 billion over 5 years from 2010.

Yes, one can put away money, but how does one maximize one’s savings?  Especially during the proverbial post-holiday cash crunch, as in the aftermath of an extravagant December of the previous year!  Financial experts have come up with ways to work the TFSA to everyone’s advantage. Very few investors are aware that contributions in kind are permissible, like stocks.  To elucidate, if someone cannot come up with $5000 cash, he or she can transfer a non-registered investment into the account.

There are pros and cons to doing this and one must be conscious of the tax repercussions.  Opting for this course of action eliminates the need to come up with cash, at the same time, if a stock is transferred at a higher price, the gains are taxable, but if transferred at a lower price than what was paid, a tax loss cannot be claimed. Here, one can sell the non-registered stock, invest the money in the TFSA and wait 30 days so the loss rules elapse (which would apply if an identical stock was purchased)

Another key optimization strategy was the swap.  If an investor had $5000 in a TFSA and $5000 in stocks and wished to free up some cash for some purchase, he could withdraw the cash and replace it with the stocks of the same value. This facility increases the wealth growth aspect of the TFSA. How does this happen? It is best illustrated with an example: Say a person takes $5000 out of his account in cash and replaces it with $5000 of stocks.  The stocks appreciate in value to $20,000 (in an ideal world!). If the stocks are withdrawn at this point, it leaves a residual contribution room of $20,000!

The downside to this would be the waiting period until January of the following year before the investor can re-contribute, thus losing tax-free growth in the interim. The smart thing to do here would be to swap the stocks for cash, thereby capturing the new contribution room. (It should be noted here that a TFSA swap is likened to an RRSP swap. Both feature acquisition and disposal of property at fair market value.  Capital gains arising are taxed; capital losses cannot be claimed).

Unfortunately, the Finance Department has recently introduced an amendment whereby swaps have been banned, as some overuse of this avenue was noted.  But one can still sell assets in one account and re-buy them in the TFSA and withdraw, thus minimizing the tax burden, but this is the more expensive route than swaps.

Another option is to sell the stock in the TFSA for $20,000.

So a TFSA is more than just an account into which one deposits $5000 and forgets about it.  As can be seen from the above, one can use creativity and generate more wealth than that from tax savings alone.

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