TAX NEWS - June 2010

The big one

Just because I'm insecure and need attention, I'll mention this again. After being disastrously elected a Harper MP in 2006 I gave F a fat doc on what he should do in his first budget. (He didn't ask me.)

One of my hot ideas: a Canadian version of the Roth IRA which lets Americans save money in a tax shelter and take it out tax-free in retirement. Sort of a 'tax-free savings account.'

So, shortly after F and his colleagues booted my blogging butt from the caucus room, he announced the TFSA –  the Tax-Free Savings Account – calling it the most important contribution to Canadian tax law since the RRSP. And, actually, it is. Maybe even a better instrument for average families who struggle to save anything. In fact, this big one could rescue the ass of a whole generation of retirees three decades from now.

But, as you may have seen, the TFSA has come in for a media dissing in the last few days. The origin of that was a column in the Toronto Star by a woman who usually does her research, and is smitten with GICs. She relayed the news that the CRA (which I used to run when I was a boy wonder) has recently sent out reams of letters to people telling them they face penalties for screwing up their tax-free accounts. The biggest Star scare: if you transfer your TFSA from one bank to another to get a better deal, you'll be slapped with offside charges equal to 1% of the entire amount, per month.

Well, that's not exactly true. I know. I transfer TFSAs for people five days a week.

But let's review the rules, just to be clear: You can put $5K a year into a plan, plus another $5K for your spouse, for ten grand a year. In addition, you can open a plan and deposit $5K for each kid old enough to file a tax return. This is called income-splitting and you should do it.

The money you deposit is not deductible from your taxable income, like an RRSP. Bummer. But this is offset by the fact you can retrieve it without paying any tax. In contrast, all RRSP withdrawals are taxed at your marginal rate in the year you get them – in other words, counted as earned income. This is what kills retired people who make over $65,000 a year and pay 50%.

Now, I said TFSA money can be taken out at any time, put it back in again (can't do that with an RRSP, either). But here's where most people have run afoul of the law – they're unaware if you make a TFSA withdrawal you have to wait a year to stick it back in, unless the total of the withdrawal plus the original deposit is under the $5K annual limit.

That means if you have $5,000 invested and remove $2,000 to finance a drug deal, then return the two grand out of profits a couple of months later, in CRA's eyes your TFSA was fed $7,000 in one year. So, you'll be penalized 1% a month on $2,000. However, if you started with $3,000, removed $2,000 and later replaced it, no penalty.

The second issue is when you move your TFSA from, say, the Dutch guy's shorts to a real bank because you feel like it. If you do this the wrong way – cashing out and closing the first account, then establishing and funding a new one – you will be nailed if the total of the two separate deposits exceeds five grand a year. To the CRA, you are just setting up two TFSAs in the same year for an excessive amount, which makes you rat chow.

This can be avoided entirely, however, if you just go to the place where you want your new account and give them the account info on the old TFSA. If they do an institution-to-institution transfer (or in this case, boxers-to-bank), you are totally legal.

OK, are we good?

Now, none of the above addresses the real crime being committed by millions of people within tax-free savings accounts, which is using these suckers for saving. That's like dating Ashley Greene and forgetting your Cialis (is my age showing?). Wasted opportunity, dude.

The point of investing inside a tax shelter is to select assets which grow like weeds since none of the gain is reportable as taxable income. That means GICs or 'high-interest' savings accounts are useless. Given that the most you can now have invested in a TFSA is $20,000, the typical savings vehicle will offer annual interest of two or three hundred bucks – and that's nibbled away by the annual fees many of the greedier banks and brokerages charge.

Far better to invest in equity-based assets like sector ETFs, for example, which will likely suit you very well over a decade or two of pre-retirement investing. Rule of thumb: stuff that is taxed the most (like bonds) goes inside the RRSP. Stuff taxed the least (like dividend-yielding stocks and preferreds) goes in the non-reg account. And stuff which grows the most (capital gains-producing equities) goes in the TFSA.

And if you ever run into F, just mention the Turner-Free Savings Account. He'll know.