Using your TFSA for long-term goals

Go further with a Tax-Free Savings Account

The Tax-free Savings Account (TFSA) is a natural home for short-term savings, holding investments that pay interest and would otherwise be fully taxed. However, you can also use your TFSA for long-term goals and to supplement your retirement savings.

With new contribution room added to your TFSA 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.

Don’t overlook all the benefits

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.

a) Stretch your tax 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.

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.

b) 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.

c) 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.

d) Reduce risk of the OAS clawback

If you're receiving Old Age Security payments and you expect your income to exceed a certain threshold, 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.

5. Invest in equities tax free

If you see your TFSA as a long-term accumulation vehicle to supplement your RRSPs, it could be advantageous to weight investments towards equities.ᶲ

If equities outperform fixed-income investments over time, as they have historically, the potential growth of an equity-based TFSA will produce a larger pool that can be accessed tax-free. This would reduce reliance on fully taxed RRSP withdrawals, to generate the same retirement income but pay less tax. Of course, you can't claim a capital-loss tax break if you sell an equity in your TFSA for less than it costs.

Part of a broader plan

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