The Canadian Money Roadmap
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The Canadian Money Roadmap
Making a $187,000 TFSA Contribution
In this episode, I walk through a real case study from clients of mine where I’m helping them prepare to make a $187,000 TFSA contribution.
I use this real life example to explain some of the key TFSA concepts:
- Contribution room
- What happens when a spouse dies?
- Making a withdrawal
- Over-contribution penalties
- Re-contribution of withdrawals
While this situation is unique to the client, the steps taken along the way might be relevant for you and someone you know.
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Hello and welcome back to the Canadian Money Roadmap Podcast. I'm your host, evan Neuville. On today's episode, I'm going to walk you through a scenario where I'm planning a $187,000 TfSA contribution. Yes, that is correct. This episode is all about planning for an unusually high TfSA contribution. I'm hoping that I can use this episode as a way to help put into perspective what financial planning actually looks like, in contrast to purely investment management or picking the quote unquote right ETFs or mutual funds or stocks or whatever. The financial advisor of industry often focuses just on that side of things and getting the right investments, whereas financial planning looks a lot more like high level strategy. And so this is a real client scenario that I'm walking through right now. I've changed all the names the dollar amounts are pretty close because I wanted to actually talk about the specifics there. But, yes, I've done my best to protect the identity of who's actually doing this with us here. But throughout the scenario, I'm going to use this real case study to help explain some key TfSA concepts like contribution room, the idea of a successor holder with draws over contribution penalties and then re contribution. So keep an ear open for those topics here throughout the episode. So let's get into it? How can one possibly make a contribution to their TfSA for $187,000? Well, let's start at the very beginning. And so we've got a couple here we're going to call them Larry and Susan and they decided to start contributing to their TFSAs back in 2009. And they did this with one of the other advisors here at our office. He's now retired and so I've taken over working with these clients after his retirement, but the entirety of this strategy was started and will now be completed here with advisors here in our office. So this started in 2009 when the TFSA launched, and these folks they decided that it was valuable for them to start contributing to it, even though it was pretty small potatoes at the time, because in 2009, you could put $5,000 each into this thing. Again, the idea with the tax-free savings account is that when you invest money in there, when it increases in value, when you earn dividends, if you earn interest, all of it is tax-free to you, and so, even though the dollar amounts at the very beginning were small, you kind of start to see how this might end up working in your favor long term. And here we are in 2023, that's not even necessarily long term from the perspective of one's entire life. But we're starting to see some of these scenarios where planning in advance can really lead to some great outcomes many years down the road. So, larry and Susan, they started contributing to their TFSAs in 2009, and they invested that money right away. So a lot of people think that a TFSA has to just be invested in cash or just, I guess, not invested in cash. That's a bit of an oxymoron. But many people have a TFSA at the bank and they think savings account. They think you know, saving for the next vacation and whatever. However, investing money in the TFSA is really the only way to make it work in your favor, because if you don't make any money on it, there's no tax to be saved, right? So if you invest the money in there, all of the growth, capital gains, the dividends, the interest, they're yours to keep. There's no tax on those. So they made their contributions and they invested in a diversified portfolio. Nothing crazy, nothing extreme here. We're not dealing with ridiculous home run swings type of thing. It was some stocks, some bonds, and it matched their risk profile, which is somewhere low medium to medium for people their age. So from 2009 to 2012, they each contributed $5,000 per year into these plans, some years that came out of cash from just in their bank account, and other years we would withdraw from other plans and make a contribution to the TFSA from money that they already had invested. That's a different topic that I won't cover today necessarily, but in some cases there'd be some tax to pay to get it in there in the first place. All that, to say, $5,000 per year, went into each of their TFSAs from 2009 to 2012. Then in 2013, the contribution room increased to $5,500 and it stayed that way for 2014 as well, and the reason it does that is that the TFSA contribution room is tied to the inflation rate and rounded to the nearest $500. And so for that decade pretty well, 2009, honestly until about 2021, here inflation was very, very low in most cases it was below 2% and so the TFSA contribution room didn't increase very rapidly. So it stayed the same from 2009 to 2012 and went up by $500 in 2013 and 2014. Now this is where things kind of get interesting here in 2015, because there was two things that happened in this. Again, this is a real scenario. This happened to these clients. So there was a one-time change to increase the TFSA room up to $10,000 in 2015, and there was an election this year, and so you can imagine that the party in power was kind of using contribution room as a bit of a political football here to try to entice people to see this as perhaps a long-term thing. It was not, however, too bad, but anyways, we still got the 10,000 room in 2015. Now the second thing that happened in that year when again in this real scenario was that Larry passed away, and so this is where the idea of a beneficiary comes in, and in the case of a tax-free savings account, the specific beneficiary designation that exists there for a married person or a common law partner is something called a successor holder. Let's talk about the difference here for a second. So beneficiary typically means someone who just gets a check, so the investment gets sold and you get a check for the balance. In the case of a successor holder for a TFSA, susan, who is now widowed, was able to essentially absorb Larry's TFSA in that year. This is a really unique type of thing for beneficiary designations. So in this case, at that time, they had contributed $41,000 over the course of those seven years 41,000 each, but, with the ups and downs of the market, largely speaking they had seen some positive growth. So 41,000 was contributed and it had grown by 14,000 to about $55,000 at the time of Larry's passing. So the way that a successor holder designation works is that if you are married or a common law partner and one of you passes away, the entirety of your account can be rolled over to your spouse tax-free and it can remain invested tax-free as well. So in this scenario, in 2015, $55,000 rolled over to Susan and the whole amount is now in Susan's TfSA, which is now worth 110,000. Okay, so this is where setting up your beneficiary designations and your successor holder designations can be really, really important. Moving on here, so now we just have Susan, but she has all of the TfSA room that has ever been contributed and all of the growth associated with both portfolios are now in her name and in her TfSA alone. Now in 2016, the contribution room went back down to $5,500 and it stayed that way until 2018. So we had this one weird blep of $10,000 there in 2015, but then afterwards for the next three years, susan could contribute $5,500 into the plan. So just because she took over Larry's previous TfSA because he had passed away, his new contribution room is no longer part of the calculation, new contribution cannot be obtained for someone who's passed away, so she just gets to contribute the new contribution room for herself. So, in this case, $5,500 until 2018. And in 2019, it went up to $6,000 and stayed that way until 2022. This year, in 2023, the increase jumped up from all this crazy inflation that we've been talking about forever, so the TfSA room increased along with that now to $6,500 here in 2023. Now here at the end of 2023, a new situation has shown up where Susan actually needs money for a new place. She's moving into a smaller home, but just due to the timing of when she needs to take possession of the new place versus getting out and selling her existing place, she needed to come up with approximately $180,000. In early November, yes, there's a number of options for how this could be done, but long story short, short-term financing wasn't a great option here, and so we needed to find a way to get about $180,000 to her in a pretty short notice. So, looking at her TFSA now, the current balance was slightly over that, and so what I recommended we do is actually take that money out of her TFSA, and if you've listened to any of my TFSA podcasts before, you might be thinking about how I feel that TFSA is a great long-term tool and great as an estate planning tool and all this kind of stuff. But it's also great for significant one-time expenditures, and I'll go into the context here a little bit more. So, beyond that, she sold her existing house but would only receive the proceeds in December. So there's a gap there of about a month and she anticipates getting about $500,000 for that. So you might think, okay, well, once she receives the money, she can. Just you might think that if we're making a withdrawal from her TFSA, then that contribution room is gone and you can't really take advantage of it anymore. However, that is not true. So this is where withdrawals and recontributions come into play here. So you can recontribute money, but only recontribute what you withdraw. I'll talk about a specific distinction here in a second here. But the way that the recontribution rules work is that if you withdraw a certain amount of money from the plan, you can only recontribute that money in January of the following year. So there's a calendar year reset for recontribution of TFSA withdrawals. Now, one thing to really keep in mind here is that it is based on how much is actually withdrawn, regardless of what the original contribution was. Here's another scenario that I'll kind of shoehorn in here. I've heard from many people that they bought certain stocks that went up in value. And specifically, they bought these in the TFSA and went up in value and then crashed down to nothing and now they are worth absolutely zero. So in one case in particular that I'm thinking of, he had used all of his contribution room, put the money into the TFSA, bought an investment, and that investment went to zero. Now, because the investment went to zero, what do you think? Do you think he can recontribute that money again? No, you cannot, because you can only recontribute what you take out, not what you lose. And so in this case, because Susan was taking out $180,000, she can actually recontribute $180,000, but only in January. So, even though she receives the proceeds of her house and would have the cash on hand to make that Re-contribution in December, if she makes the recontribution in December, she would be charged a penalty of $1,800, because the penalty is 1% per month on over contributions. Big yikes there, it's it's, it's very, very expensive. And so, because she had maximized her count, any Additional contributions this calendar year would count as an over contribution and would be subject to that penalty. So when the new year rolls around here in 2024, two things will happen in Susan's case. This first one is actually in everybody's case anyone that's over 18 that's listening to this right now you would have new contribution room of drumroll plays $7,000. This has not been formally announced yet, but all of the data that's required to make that calculation for TFSA Contribution room is now out and available and is public information, and so people smarter than me have done that Calculation already. Thank you to Aaron Hector, who's a great advisor in Calgary and he was on my FHSA podcast. If you want to go back and listen to the genius of Aaron Hector, I'm thanking him for doing the math on this one. So new contribution room coming up in 2024 of $7,000. The second thing that happens in Susan's case here Is that she can re-contribute anything that had been withdrawn from her TFSA in previous years. This is really cool because you can re-contribute the entire withdrawal, not just the original contribution amount. So for her situation over the years from 2009 to 2023, including Larry's from 2009 to 2015, a total of $129,000 has been contributed and at the time, regardless of what the market does here and there and whatever it had increased pretty significantly to $180,000, and so when she makes her re-contribution, the original contribution room of 129 doesn't matter anymore. It uses kind of like a high watermark principle and so, again, whatever is withdrawn from the plan can be Re-contributed to the plan. You don't reinstate original contribution room or anything like that, and so investing your money inside of a TFSA is critical that you do it in such a way that is diversified and Isn't really taken home run swings with the opportunity for permanent loss of capital. That's just my take on how I've seen things go very, very wrong for TFSA investors. So again, two things that happen in 2024 that's coming up here new contribution room of $7,000 plus the Re-contribution of anything you had withdrawn in the previous year. So now that she has the money from the house sales, she can re-contribute the hundred eighty thousand dollars plus the seven thousand dollars of room for 2024 hundred eighty seven thousand dollars. So this is awesome because again, this money is protected from tax and it can be reinvested exactly the same way as it was before and Nothing on her tax return will show up. There's no penalties or anything like that. Another cool thing is, because it's just her, now she can actually name beneficiaries and yes, beneficiaries, not successor holders, because she doesn't have a Spouse. But she can name beneficiaries and those can be her adult children, and If she were to pass away, then the remainder of that account would be Protected from probate, protected from income there's no taxes and so if and when she passes away, the money will be split 50-50 between her two kids, and it's about as clean as it gets. So making sure that money is back in the TFSA, even if it's not Intended for very high growth purposes or anything like that. Now that it's kind of being designed as an estate planning tool for Susan, it's a it's a really great mechanism to achieve that goal for her. I thought this was a really great way to utilize her TFSA Because it allowed her to be able to use her investment gains that she had had over the years and those original contributions to make a large one-time purchase. Essentially, she's acting like her own bank, providing short-term financing a little bit, but there's no cost to her to do it and there's no taxes. And the important thing is that when this withdrawal is made, nothing is reported on her tax return, even if there's some sort of mechanism to to pay less tax or have some credits or something like that, because there are other things for folks that are over 65 that are income tested other benefits like old age security. So old age security is another government benefit, kind of like CPP, except it's not based on you contributing to the plan, but it is designed for people that have low incomes, and so if you have a high income in a given year, they will start to you reduce your OAS benefit next year. We call it an OAS clawback. I think that's a great term. It's not an official term, but everyone uses it. But the thing to keep in mind there is that we often use the language of income, but it's really taxable income, right? Because she has $180,000 going into her bank account, that does not count as taxable income, and so her OAS or old age security will not be impacted by this withdrawal. Other things that folks over 65 qualify for are things like the age amount tax credit. So once you're over 65, you qualify for a tax credit. In many cases it can be over $1,000 worth of benefit, but that gets scaled back based on your taxable income. Again, the TFSA withdrawal is not taxable income, and so she has the flexibility and the opportunity to use her TFSA for a great purpose to be able to get into a new home and have no stress about missing out on other benefits that she is rightly entitled to due to being a Canadian and due to her age. The same could not be said about having this money inside of an RSP or a RIF, because while you still could take money out, you would have to pay tax on all of it and all of it would show up on your tax return, limiting your OAS and your income tested benefits. There's many others that could potentially be there as well, depending on your situation, and $180,000 would definitely be over that threshold for any of these benefits that I've talked about here. So, anyways, I thought this would probably a cool way to show you something that I've done with a client in real life and show you kind of what financial planning looks like over the course of more than a decade of planning to be able to use something really effectively and exactly for how it was designed. There's no loopholes here. This is how it's supposed to work. But you wanna start the way that you wanna finish. You wanna name your successor holder. If you have a spouse or a common law partner, you wanna set those things up correctly. You wanna take advantage of your contribution room whenever you can, be aware that when you make a withdrawal, the only thing that matters is the withdrawal amount, not the original contribution room. Be aware of those penalties of potentially over contributing and, when the new year rolls around, make sure you take advantage of your contribution room whenever you can. Last thing that I haven't talked about here is that if you have not taken advantage of your entire TFSA room, that's okay. That's totally fine because it carries forward as long as you haven't used it. I talked about the issues of withdrawing and recontributing, but even if you haven't used your contribution room, it carries forward along with you. So many of you listening here will have unused contribution room, and that is totally fine and it's great because you can use it again in the future when you have more income to do so. So this was interesting and valuable to you. I'd love to hear about it and send me an email. I've got tons of these little case studies of unique situations that you might not run into in your own life, but you can help see some scenarios that could paint a picture of what good financial planning could look like for somebody. If you found value from the episode. I'd love if you could leave a rating or review on the podcast platform of your choice. Apple Podcast lets you write reviews, but even a rating does a lot to help other people find the show and know that it could be valuable for them too. So, anyways, thanks so much for listening today and I'll catch you next week on another episode. 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 Neufeld is a certified financial planner and registered investment fund advisor. Mutual funds and ETFs are provided by Sterling Mutuals Inc.
