The Canadian Money Roadmap
Invest smarter, master your money, live & give more
The Canadian Money Roadmap
Your TFSA Questions Answered
I received a few questions after my last TFSA episode so I thought I would answer them for you here:
1. How do you invest in stocks in a TFSA?
2. What are the factors to consider between TFSA and RRSP for high income earners?
3. What happens to your TFSA after you die?
4. Can you get your TFSA contribution room back if you make a withdrawal?
Retire With Evan
Become more confident with your money - Financial Foundations Course
Hello and welcome back to the Canadian Muddy Roadmap Podcast. I'm your host, evan Newfield. Today's episode I'm revisiting a recent episode I did on TFSAs because I got a bunch of questions, so this is a bit of a TFSA Q&A. Welcome back to another episode here. If this is the first time you're joining me, my name is Evan Newfield. I'm a certified financial planner based in Saskatoon and I started this podcast to help Canadians understand the complexities of the Canadian financial system so they can make better decisions with their money. Big thing that I really like talking about is the tax-free savings account, or TFSA, because I think it is underutilized and misunderstood and is also extremely valuable for people who want to build wealth and retire and pay less taxes. If that sounds like you, welcome here this episode. I'm going to cover off a few questions that I received in response to my last episode I did on TFSAs. Thought I would strike well the iron's hot and for those of you that submitted questions, I hope this covers them. First question, kind of integral to understanding the whole concept of what I'm trying to get to here with TFSA investing and this comes from Dan, and Dan says can you explain what you mean when you refer to investing in the stock market via TFSA. Yes, I can. So a tax-free savings account is a terrible name for what it actually is, but it should be a tax-free investing account. Financial planner Jason Yee, who I connected with on LinkedIn recently, he suggested why don't we just call it something really simple like the tax-free money account, because everyone loves tax-free money? Yeah, because you can do all sorts of things with the account. Think of it just like a bucket that you can put things into it. The idea that it's called a savings account really trips people up, because a savings account is usually just that thing that you have at the bank, where money sits there and you don't make anything. The problem is, if you're not making any money, there's no tax to be saved in the first place. So what you need to do in your TFSA is actually invest within it. So you can open up a tax-free savings account with an investment advisor like myself, or with an online brokerage or a robo-advisor or at the bank, something like that and once you have opened the account, you can transfer money from your bank account into your TFSA account and then you have options to buy investments like ETFs, mutual funds, or leave it in cash. So typically when I talk to people about investing in the stock market via their tax-free savings account, I mean they take the money that's in their TFSA and they invest it in mutual funds or ETFs that are invested in stocks. So I don't recommend that people pick and choose individual stocks in their TFSA for a variety of reasons. One, it's really hard to do. Two, statistics say you're more likely to lose money. And three, if that's true, if you're going to lose money on it, you don't get that money back and there's no sort of tax benefit or anything like that to claiming a loss in your TFSA. That contribution room has just gone forever. I'll get to that concept later. But if you have something very well diversified like an ETF or a mutual fund, you can own that inside your TFSA so that the growth that happens from that investment stays tax-free forever. Again, the only benefit to it being tax-free is that you have to make money. So you put $1,000 in and 40 years down the road it's now worth $5,000. You get a $4,000 gain along the way and you get to keep all of that money. If that was in an RSP, all of that money would be taxed as income. If you just had it in a non-registered account, you would pay capital gains tax on the amount that it has increased in value. I won't get into that one here, but essentially that's all it means to refer to investing in the stock market via a tax-free savings account. That speaks to the main misunderstanding around what a TFSA is. Most people say, yeah, I have a TFSA at the bank and the returns are bad. Know, what you have is a TFSA masquerading as boring old savings account, because when these things launched, all of the banks really latched onto this and they said wait a second. Savings accounts, that's what we do. We do savings accounts, so everybody should have one of these things and they should have at least 500 bucks in there. You would not believe the number of people that I speak with that say that, yeah, I've got this TFSA at the bank, I've got 500 bucks sitting in there and I don't really know what it's doing or whatever, but it's tax-free. It's like what do you mean? It's not tax-free, it's not making any money, it doesn't matter. So the TFSA is just a bucket to put things in. You can put cash in it, like the people at the bank have often encouraged you to do. That's fine, but there's no benefit because it's not making any money. I would encourage you to use a TFSA as part of your long-term investing strategy, perhaps as a tax-free retirement account, and see the money that you put in there as your long-term money. The benefit there is that the more time you have to let your TFSA investments grow, the more benefit is to you, because you get to keep more of that growth tax-free. So hopefully that got to the root of your question there, dan. If it didn't, please send me an email. Hello at evanueveldcom and I'll do my best to clarify even further. Next question comes from Dennis. Dennis says I earn between 140 and 150k per year. Could you do a show on RSP versus TFSA for high-income earners? I have no spouse and two adult children. Thanks for the question, dennis. Okay, so I can't really give a specific answer to this question, necessarily, but I will discuss the factors that I would look at when trying to decide this. For a client of mine that might be in a situation like them. The first thing I would want to know is your approximate timeline for needing this money. I suspect that you want to invest this for the long-term, if you're kind of comparing the TFSA and RSP. I mentioned in the previous question that I would encourage people to use the TFSA for long-term investing. However, the fact of the matter is that you can use it for short-term savings, and I've done that before too. So, because there is that option there where you can take money out of the TFSA and put it back in a subsequent year, you can use it for short-term things as well. So I would want to know your timeline. So let's just assume that this is retirement money. Okay, that's a good place to start. Another factor that I would want to know before making a recommendation there is what other sources of taxable income are you going to have in retirement? Because I was speaking with one of our other advisors here at the office and they're speaking with a client that has about $1.4 million in a locked-in retirement account. So that's an old pension, and they are not high-spenders by any means, and so the minimum withdrawals that'll end up coming out of there again, they're all going to be taxable. Even just the minimum withdrawals out of a plan that size at age 71, will keep them in at least the middle tax bracket for their whole life, and so the main benefit with an RSP is trying to get some sort of tax differential benefit where you contribute in a high tax bracket and you withdraw on a low tax bracket. But if in your case theoretically, if you had a lot of taxable income or you're projected to have a lot of taxable income in retirement, adding more to your RSPs right now might actually work against you or end up with a net neutral lifetime outcome and you'd probably be better off in a TFSA. Also, in that case, if you have so much money in RSPs or pensions that you're not going to spend it during your lifetime and you'd be projected to pass away with money still in those accounts, in almost every case, having more money in your TFSA will end up allowing your kids to be able to inherit more of your money after the tax has been accounted for. So, anyways, there's lots of factors there, but that's one thing. So how much other taxable income you plan to have in retirement? These are in no particular order. But another thing that I would want to know is what do you typically do if, when you contribute to an RSP, what do you do with your refund? Assuming you're not self-employed and you have employment income what happens is, when you put your money into an RSP that creates a deduction on your taxes, and so you get a refund of the taxes that you already paid on that money. Whoa, it's a bit of a bit of a mental gymnastics there. But say you're in the 30% tax bracket and you put $1,000 into your RSP. When you file your taxes next year, that means you get about 300 bucks back, okay. But but say you retired the next day and you wanted to take that $1,000 out, you pay taxes on that $1,000 again, right? So say you're in the 30% bracket when you're withdrawing your money you can do the math here so that that 300 bucks that you got at the beginning, that's not a bonus, that's not free money. It's essentially just forwarding you the tax money that you'll have to pay in the future. So what you have to do with that RSP refund is Invest it in such a way that it is working for you, as opposed to another way to just spend more money. Now that's fine, but we're now having a different conversation. Okay, so if you are comparing the RSP in the TFSA, what you decide to do with your RSP refund is pretty much the only thing that matters there and in terms of a long-term Projection. Because again. Let's say you put a thousand dollars into your TFSA. 40 years down the road it turns into 5,000. Okay, now you can withdraw 5,000. You get to spend that if you do the same thing in your RSP. You put in your thousand, you get your refund of 300 bucks and you spend it and now your RSP is worth five thousand dollars. I'm using hypothetical numbers here, but whatever, and you withdraw that five thousand from your RSP, you might be left with thirty five hundred. Okay, so the RSP is an investment maximizing tool, not a tax minimization tool, and the only way to do that is to reinvest that refund when you get it. How many people do you think are doing that? Not that many RSP refunds and tax refunds in general Usually end up going towards more spending. Comes right around spring break time and so going on that warm trip to Florida or California or Mexico or whatever pretty common Home renovations, paying down debt. It doesn't mean it's all frivolous or bad ideas, but it's not Accomplishing the same goal. So if you were planning on Spending it or like, I'll come up with a way to spend that refund, I like, I like getting a tax refund. Okay, I've got a lot more educating to do in that regard. But if that's your mentality, when you get a tax refund, when you contribute to RSPs, I would say you should do a TFSA and get out of your own way and make sure that your long-term Growth can be kept in your pocket as opposed to pre-spent on a bunch of other garbage that you're gonna forget about. I'm being facetious here, but that matters, okay. Another thing that I would consider here. There's many other considerations, but I'll just finish off with this one. One consideration that's really important is what province are you in? Because when you contribute to an RSP, like I said before, you want to get your most bang for your buck, meaning you want to contribute in a high tax bracket and and withdraw in a low tax bracket. So when you contribute, it matters what tax bracket you're in at that level of income. So, deniston, let me know which province he lived in, which is totally fine. But let me give you a little example here. So if he he says he's making a hundred forty thousand dollars, there is a huge range of Different marginal tax brackets you could be in depending on what province you're in. So, at $140,000, if you're in Quebec, the marginal tax rate at $140,000 is 47.46. Okay, in that case RSPs might be a good option theoretically again remembering all my other factors to consider. But if you're in Alberta, your marginal tax rate is only 36%, so that's a difference of over 11%. So when deciding to contribute to RSPs or TFSAs, this stuff really really matters. So what province you're in, how much income you have, what other taxable income sources you're going to have in retirement, how much you project to have at that point, what would you do with your refund and your timeline? There's a lot. It's not a simple answer and it's really specific to each individual person. And so when people go through my money roadmap GPS program, so that's kind of like an introduction to financial planning. That is one of the key things that we determine for that individual. It's part of their system that we kind of come up with together to determine what's most important for you, what timeline you're on, how can we save the most taxes over the course of your lifetime. But yeah, little plug for my money roadmap GPS financial plan, you don't have to have your investments with me. So this would be a great option for DIY investors or people that work with an investment advisor that doesn't offer financial planning. This could be a good option for you. If you want some more info about this and pricing and how the money roadmap GPS program can work for you, I've got a little link in the show notes here. Feel free to check it out. Okay, next question comes from Joe. Joe says good stuff. I wanted to ask if my wife and I pass away, does the TFSA money go to our kids TFSA or do they have to take it out of the TFSA? That's a really good question, joe. Okay, so first things first, to open a TFSA, in the first place, you have to be at least 18 years old. So if your kids are like mine and they're one in three, you cannot have a TFSA in their name. Yet you have to be 18 years old to have a TFSA. So that's first thing, that you didn't ask, but something that's important. Then I'll explain how things work when you pass away with the TFSA. So with a TFSA, you can name both a successor holder and a beneficiary. I'll explain what those are. So a successor holder is only available to a spouse or a common law spouse. And what would happen? There is, joe, let's say you passed away and you named your spouse as the successor holder of your TFSA, then she would be able to absorb your TFSA whatever you've put into it, not your contribution room, but just the dollars that are currently in your TFSA. She would absorb that into hers. And let's say, for example, both of you have a maxed out TFSA. She would then have a double TFSA and it would all be able to remain invested and remain tax free. It's a fantastic way to go. So if you have a spouse or a common law partner, you can name them as your successor holder and I would highly encourage you to do that. But let's say the next order of operations happens there. Say you've passed away Joe and your wife is left. She's got her double TFSA. Now you've got kids. Let's say they're in their 20s at that time and she passes away. This is a morbid answer here, but anyways. So say she passes away. What happens there is, because she doesn't have a spouse anymore, she cannot name a successor holder on the TFSA. What she can do is she can name the kids as beneficiaries. So in this case, when she passes away the kids let's say there's two kids they would get half of the balance of the TFSA each. No taxes, no taxes go back to her estate. No income taxes show up for them. There's. No, we don't have estate taxes. We don't have gift taxes. We don't you know some of these things that you might have heard of from the US. No, in this case, if they were named as beneficiaries of the TFSA, it bypasses her estate entirely and they would go to the kids. However, to speak to your specific question, it cannot go directly to their TFSAs. That option is only available to a successor holder which is a spouse or common law partner only. So, yes, they would have to take it out of the TFSA. However, if they were the age majority, so at least 18 years old, they would be able to take that money and contribute it to their own TFSA, but their contribution room would be based on their age and have nothing to do with what you and your wife had accrued over the course of your life. Good question, so far, okay. Last question here comes from Josh, and Josh asked if I make a withdrawal from my TFSA, do I lose that contribution room forever? Great question, easy answer Nope, you lose that contribution room for the rest of that calendar year. In January, the January 1st of the following year, anything that you withdrew from your TFSA before you can now re-contribute again in the following years. This is really only super relevant if you're maxing out the contributions on your TFSA every year, because say you have $88,000 of room and you have $5,000 in there and you take 2,000 out. Well, you have so much extra contribution room above what you've already put in that it doesn't really matter. But say you're at the maximum, say you put in $88,000, which is lifetime maximum, and you withdrew it. If somehow you stumble into another $88,000 later on in the year, you cannot re-contribute that money until January of the following year. Okay, so it's awesome. That's another reason why a lot of people think that it's great for short-term savings and they're not entirely wrong there, because you can contribute that back into the plan at a future date for a different purpose. I've done this before where I've been saving for a house. Take the money out for the down payment the following year. You can fill it up again, in my case aiming towards more long-term investing. Here's a fun little wrinkle on top of that. So let's say in my example again, you put in the $88,000 maximum, but it grew to $100,000 because it's been invested the whole time. So now you have $100,000 in there and you take all of it out. The cool thing is nothing ever touches your tax return ever. Even though you have growth in there, none of it is taxable. You get to keep all of it. You can go spend $100,000. Now the next year, when January rolls around, you have your $88,000 of room plus the new contribution room. For that year, however, that amount is gonna be less than $100,000. The cool thing is your re-contribution amount uses. I think of it like a high-watermark principle where you don't just put the money back in based on your contribution room at that point. You can put money in based on what you withdrew. So in this case my hypothetical example take a hundred grand out. January 1st rolls around, you can put a hundred grand right back in. So if you've made money, you're not penalized by withdrawing because you can always put that money back in again afterwards. So it's a really, really flexible plan that way and it does not penalize you for being an investor or for making money in it, because even if you have to withdraw earlier than you anticipated or something like that, you can always put that money right back into the plan Again the following calendar year. So I hope this episode was valuable for not just Dan, dennis, joe and Josh, but for any of you that had some questions about TFSAs. I would be glad to do another episode like this again. So if you do have questions about TFSAs, hit me up at hello at evannewfieldcom. My link to that email address is in the show notes of this episode. Shoot me an email, let me know what questions you have and what I can answer for you regarding the tax-free savings account. Thanks for listening. We'll see you next week. Thanks for listening to this episode of the Canadian Money Roadmap Podcast. Any rates of return or investments discussed are historical or hypothetical and are intended to be used for educational purposes only. You should always consult with your financial, legal and tax advisors before making changes to your financial plan. Evan Newfield is a certified financial planner and registered investment fund advisor. Mutual funds and ETFs are provided by Sterling Mutuals Inc.
