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Posts Tagged ‘TFSA’

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  Non-registered investments like stocks can be put in and if they appreciate in value and are withdrawn, then that creates extra contribution room to the tune of the value upon withdrawal.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swaps between an RRSP and a TFSA can slowly but surely transfer funds from the former to the latter and then be withdrawn tax-free.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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Why is the TFSA a good investment option for a twenty-something?

August 15th, 2010

The Tax Free Savings Account is an excellent option for the 20-something investor.  20 is a good age to start thinking about creating savings.  Some people are ahead of their time and have earned a lot of money at this point: they would surely want to do better than a Youth Account, which pays very little interest!  20 is also above the 18-year age limit of the TFSA.

For this age group, it would be advisable to, first, set up an automatic transfer system, as in a certain percentage of their earnings each month set aside for investment into the TFSA.   If one banks online, this is easy to set up and does not need much monitoring.  This is for those who do not have $5,000 right away.  (Of course, Mom or Dad can come in quite handy over here and, possibly, make their own contribution to encourage the saving streak in juniors!  Just perhaps include the clause that the money cannot be touched for whimsical expenditure and specify the time period as well!)  Parents will not be hit with any sort of taxes for their generosity, as there are neither attribution rules nor tax implications with the TFSA.

Even if one is married at this age, which is often the case, spousal contributions are permitted.  Withdrawals can be easily made with no fees and the account can be replenished at any time without penalties.   This account is easy to manage at this stage in life especially because, from a taxation point of view, it is fairly simple to figure out and way easier on the bank account…and the nerves!  It offers much leeway to the investor.

So when should one launch off into the TFSA world?  As early as possible, as soon as one hits 18 preferably!  (Or, back to our previous strategy of getting one’s parents to set the ball rolling, even before 18!  The parents can manage the account until the statutory age is reached.)  That way, by age 20, one is already in a savings groove so to speak, and has a feel for how everything works.  The longer one can have tax -sheltered savings, the further it goes towards making one rich.

A lot of 20- something year olds would balk at the mere mention of $5,000: while some adults’ scoff at how paltry the sum is, it seems enormous to the youngsters.  Stay in faith; where there’s a will, there’s a way!  Apart from the usual ideas of hosting a garage sale and going on eBay to sell your designer clothes, don’t forget that trusty source of all things good: your parents!

Here, a sales pitch has to be carefully formulated.   Aim for honesty, which is always the best policy!  Then, highlight what’s in it for them.   Adults despise taxes and will do anything to minimize them legally, and this is universally true.   The people who love paying taxes have just got to be in the minority!  (Hopefully by this time you have already created a foundation of trust with your parents by keeping curfews and doing chores!  If not, a good time to start would be before you deliver your sale’s pitch!)   Inform your parents that there are no tax attribution rules, and they can consider this as good tax planning: if they give you your inheritance in advance, you will be judicious with it and allow it to accumulate.   You can offer, as well, to keep all documentation transparent, give them full online access, and invite them to monitor it regularly with you on a set schedule.   This could also afford an opportunity to do things as a family and spend more quality time together.  The TFSA can also be used like an RESP for future studies, with way less restrictions.

If you are living apart and have your own job, consider moving back in with your parents to save on the rent which can be invested in the TFSA.  Many parents, especially those getting on in years or those who do not have too much company, might welcome this greatly.   Of course, offer to contribute to some of the household expenses and certainly pull your weight to make this more appealing to Mum and Dad!

How would a 20-something get the most out of the TFSA?   By adopting these strategies as are elucidated in Gordon Pape’s Ultimate TFSA Guide:

1. Go all the way and deposit $5,000 into your account per annum.

2. Invest in early January of each year as contribution room of another $5,000 becomes available each year.

3.  Educate yourself about contributions in kind or swaps and try to maximize your return.

(Gordon Pape’s Ultimate TFSA Guide would provide more information on these.)

If one is still studying at this point or has only recently joined the work force, the TFSA has none of the restrictions of the RRSP in terms of percentage of income that can be contributed.   You or your parents can open a self-directed TFSA and deposit $5,000 even if your earnings are nil.

Go for it!   The TFSA can take you places!   Start now!  The sky’s the limit to realizing your dreams!

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The Tax Free Savings Account and You at Various Times in Your Life

July 3rd, 2010

The TFSA is an amazing vehicle for savings and can be molded to suit people in various walks of life and at different times in their life.  Many experts especially recommend the TFSA if you fall within the bracket of medium to low incomes.  It would benefit you greatly and serve as a means to accumulate and grow wealth.

In this discussion, we are going to cover three categories of people:

– Those who are a decade away from retirement.

– Those who are a year away from retirement.

– Those who are under forty years of age.

A Decade Away from Retirement


If you are a decade away from retirement and earn close to $80,000 per annum and already have an RRSP, stay there and use your annual tax refund to invest in your TFSA.   This would act as making Government money do double-duty in a sense.   Try to max out the yearly contribution of $5,000.  This strategy gives you the best of both modes of investment and brings your taxes down.  Having the TFSA in addition allows you a little more room for emergency withdrawals as you can avoid being taxed on these.   If possible, leave the money in the TFSA or open two TFSAs within your contribution limit, earmarking one as “not to be touched” and the other, as a “just in case” fund.   (Only in the most extreme cases when there is no other option, will you dip into your second TFSA.)

A Year Away from Retirement


If you are only a year away from retirement, then the TFSA is the way to go.  Some people might think this is too late to start but that is so far from the truth; it is among the best times to start!   It doesn’t make sense to keep depositing money into a fund that you will soon be emptying out.  (RRSP) The TFSA, in this case, is the treasury where you are accumulating wealth and thus, tax-free income as well as capital outlay that is often required once retirement sets in.

You should have a goal in mind, which gives direction, and certainly start to be proactive.   Decide that the account will not be touched for a lock-in period, which you impose on yourself.  You really do have to do that to see the exponential effects of the tax-free interest being reinvested and yourself earning interest on that growth and then further interest.  A fun thing to do is to not check your account too regularly, (except, of course, if you have stocks in it), and surprise yourself!  So your aim at this point must be intense savings and investment in the TFSA, cut corners where necessary, eat vegetarian pasta twice a week (they say this saves a whole lot!), do what it takes and top up your wonderful TFSA which is the ticket to your dreams!

Make sure you keep an eye on contribution room and don’t exceed it and incur penalties for yourself (1% per month until the excess is withdrawn), and don’t fall below it for not having made the most of carry forwards:  unused TFSA contribution room does get added on to that of the subsequent year and so do withdrawals.

For the Person under Forty Years of Age


A Tax Free Savings Account has great pertinence to people less than forty years of age.   The family is younger at this point and many contingencies crop up; unexpected expenses are faced.  This way, you can earn interest and make tax-free withdrawals as well without the worry of number of withdrawals and being penalized for taking money out.   But even in this case, I would recommend more than one TFSA.

Have one with the bank you don’t normally use for daily transactions (so there’s less temptation to dip into it!).  Into that TFSA, make an arrangement for money to go out of your main account as soon as you get paid.  This should be a standing instruction and non-negotiable.  The rule you impose upon yourself and your spouse is that this is the account that cannot be touched, no matter what.  If your spouse is working as well, better still, have the same arrangement set up with their account.

Keep an eye on the upper limit of contribution of course.   If you are adventurous, you can opt for an investment in a form other than cash.  But this is not recommended at this point, when time is at a premium and savings must be built, you will not have much time to monitor investments.   If you and your spouse can contribute the maximum possible to your respective TFSAs, that would be incredible news!  This could bond families closer as well, with the common financial goal of growing wealth.

Then you can have a second account, which is the emergency fund, and that one can be touched when there is dire need.  So you could do $4,000 in the first account and $1,000 in the second.   Or choose whatever ratio you find suits you.

The Tax Free Savings Account certainly widens people’s horizons and adds to their range of choices.  The TFSA also represents potential freedom.   It provides liquidity, your money isn’t locked in the way it is with other accounts, and you can take it out at will (but do exercise some discipline with that last one!).

Initially it may not seem like much but soldier on and keep investing and you will find yourself happily surprised pretty soon, that’s for sure! Certainly from year 2 onwards!

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