Especially in a low interest rate environment where it is difficult to beat inflation and tax erosion without incurring market risk volatility, any rollback of the Tax-Free Savings Account (TFSA) contribution limit to $5,500 from the current $10,000 would affect seniors, as well as young adults trying to save for their futures, too. Despite political controversy, the reality is that the TFSA has gained broad-based acceptance by 40% of average Canadians. More than 80% of all TFSA holders have incomes of less than $80,000, according to the April 21 federal budget documents. These are hardly the wealthy few. In fact, TFSAs have become a crucial financial planning tool for seniors, and any rollback would have serious implications. Here’s why.
The virtues of a tax free savings vehicle for family wealth creation are significant and should be front and centre in year-end tax planning activities now. Here are the top five tax reasons why seniors shouldn’t miss taking a closer look at maximizing their TFSA investment:
1. Family income splitting. There is no attribution rule attached to the TFSA, because resulting income is tax exempt. So this is a great opportunity for parents and grandparents to transfer $10,000 each year to each adult child in the family –for the rest of their lives. Recipients can take the money out, tax-free, for whatever purpose they wish and create new TFSA contribution room in the process. That is, they can take withdrawals and, once they have accumulated new savings, can put those amounts back in future years to grow.
2. New tax-sheltering opportunities for RRSP age-ineligible taxpayers: The RRSP tax shelter can continue for those who reach age 71 and have to convert their RRSP to a RRIF or annuity. Even if they don’t need the money, they are forced to take in withdrawals. Amounts not needed for their living expenses can be reinvested into a TFSA, allowing those tax-paid funds to grow again – and faster – in a tax-sheltered account, as opposed to a non-registered account.
3. Benefits for single seniors: RRSP melt-down strategy enhancements. It has always made some sense to melt down RRSPs, converting to a RRIF or annuity and take withdrawals to “top income up to bracket” in circumstances where taxes will be higher at death than during life. We generally use that strategy for singles or widow(er)s, for example. Now those surplus funds can be deposited into a TFSA so that retirees can continue to build wealth on a tax-free basis and keep legacies intact.
4. Avoid high-income tax brackets and surtaxes. Savings within a TFSA are also a great way to reduce ongoing income tax burdens and taxes payable on death of a surviving single taxpayer. During life, untaxed RRSP accumulations do not qualify for income splitting in the hands of the surviving spouse. As a result, withdrawals can quickly be taxed in higher-income tax brackets now popular with provincial governments. Withdrawing some of these tax-sheltered accumulations before death (at lower tax brackets) and reinvesting in a TFSA can help to limit high tax obligations for the surviving spouse and ultimately for family heirs.
5. Estate-planning considerations. Note that the TFSA loses its tax-exempt status after the death of the planholder, meaning the investment income earned after death will become taxable. However, a rollover opportunity is possible when the spouse or common-law partner becomes the successor account holder. This rollover will not be affected by the spouse’s contribution room, and will not, in turn, reduce their existing room either. In the case of a taxpayer dying without a spouse, the plan assets should be transferred to another appropriate savings vehicle. Best opportunity? Beneficiaries receive the funds and contribute to their own TFSA.
Estate planning is one of the big reasons that putting more into the CPP is not always a good idea. Aside from the fact that it’s contributory – meaning it will eat up some of the precious funds that could go into the TFSA, and generates a taxable pension instead – the survivorship benefits are not as good as the TFSA offers. The CPP death benefit has been stuck at an unindexed amount of $2,500 for years, and if both spouses qualify for a maximum retirement benefit, the surviving spouse will receive no additional CPP retirement benefits stemming from the deceased’s contributions.
Certainly the opportunity now is to take advantage of the TFSA maximum contribution limit to $10,000 for 2015, just in case the political winds change.
Courtesy Fundata Canada Inc. © 2015. Evelyn Jacks is president of Knowledge Bureau. This article originally appeared in the Knowledge Bureau Report. Reprinted with permission. All rights reserved.
