After being introduced in 2009, tax-free savings accounts (TFSAs) are becoming a bigger draw for clients looking for more ways to split income.
Part of the attraction is that the maximum contribution limit has now grown to $20,000 per taxpayer (based on $5,000 per year). In addition, TFSAs offer a way for many families to reduce their taxes by starting TFSAs for more adult family members - without triggering the attribution rules.
For instance, parents and grandparents may contribute up to $5,000 per year for life to a TFSA held in the name of each adult child in the family. In addition, one spouse may give the other up to the same amount to invest in a TFSA without incurring attribution. And if these amounts are withdrawn from the TFSA, they do not attract attribution. The only significant limitation is that TFSAs may be set up for only those 18 and older.
As the new year approaches, and with it the opportunity to invest another $5,000 in a TFSA, you may want to review these options with those among your clients who are able to take advantage of them.
"Frankly, it gives you the opportunity to do income-splitting without worrying about the rules surrounding income-splitting," says tax accountant Gena Katz, executive director at Ernst & Young LLP in Toronto. "A high-income earner in the family can take care of providing a savings vehicle. It is after-tax dollars that are used initially, but if you take those after-tax dollars and you make a contribution to a spouse's TFSA, the income that otherwise would have been earned on that in your hands is now tax-free [in the spouse's hands]."
Such contributions can add up, says Katz: "An individual can only put $5,000 into his own account. So, if you have a couple of adult kids and a spouse, then, effectively, it's $20,000 a year that you can invest for the family on a tax-free basis. Here you have a savings vehicle with a lot more flexibility [than an RRSP] in terms of being able to take out money [tax-free] at any time."
Consider this example from Toronto-Dominion Bank: $5,000 is deposited into a TFSA each year for 45 years, for a total of $225,000. Assuming an annual 5% compound rate of return, the investment would be worth $838,426 at the end of the period.
By comparison, a similar annual deposit invested outside a TFSA would be worth only $547,420 because of the taxes on the growth inside the account.
Warren MacKenzie, president and CEO of Toronto-based Weigh House Investor Services Inc., says that financial advisors need to provide their clients with a financial plan that clearly shows the benefits of a TFSA "because $5,000 a year, which is the current contribution limit, doesn't seem like it makes much difference. But when we do a financial plan and we show the compound effect for the next 30 years, it's almost a staggering amount."
There are other benefits in using a TFSA that can be shared with family members. MacKenzie notes that monies withdrawn from TFSAs do not affect eligibility for a range of income-tested government benefits such as old-age security (OAS). Thus, it may be possible to avoid clawbacks of OAS and other benefits for more family members. Says MacKenzie: "That's a huge benefit."
TFSAs also can be useful for estate planning. Upon death, amounts in TFSAs can be transferred without tax to surviving spouses and not affect the survivor's own TFSA contribution limits.
The annual contribution limit tracks inflation and, when warranted, will increase in increments of $500.
"I'm expecting that in 2013, the limit may very well be $5,500 because it hasn't grown yet and inflation is a factor," says Mackenzie.
"If it is $5,500 next year, then in another three or four years, it's up to $6,000. I think the TFSA will become the most effective financial tool we have." IE
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