Good-ish News: TFSA Limit Rising to $5500 in 2013

Caught this item on Investment Executive saying the government has raised the TFSA annual contribution limit for 2013 to $5500, up from the $5000 it has been for each year since TFSAs started in 2009 (here's the official press announcement). It's only good-ish news since it isn't an increase in real terms, only compensation for past inflation. As the Department of Finance backgrounder shows, we've been behind inflation through 2012 and now the rounding method will push the limit slightly ahead of inflation for a year, perhaps two. Of course, if you didn't use the $5000 limit from any previous year it has carried over and accumulated but the new annual amount only applies going forward, not also backwards to previous years (see the CRA TFSA info page). Roll on January 1st when the 2013 contribution can be made, I'll be doing it.

Pooled Retirement Pension Plan Draft Legislation Revealed - Will PRPP Help?

Last Thursday November 17th, the Federal government announced and tabled draft legislation (Bill C-25) for creating Pooled Registered Pension Plans.

Will this help the target group - people who have no company pension and are not voluntarily saving through RRSPs or TFSAs? The answer is a mild "yes" in absolute terms and a resounding "no" in relative terms.

Yes, it does help somewhat.

• Anything is better than nothing - The most critical problem is that those people right now are not saving for retirement, so any program that gets them to save will help. Despite the provisions of the PRPP legislation that do not require companies to opt in and that allow individuals to opt out, the default auto-enrollment rule (par.39(1)), the default investment option rule (par. 23(3)) and a default contribution rate (par.45(1)) will be quite effective in getting more people to save. "Nudge" works.
• Cost and fees have a fair chance to be less than for mutual fund RRSPs - Why might there be a grain of truth to the confident assertion by Minister Menzies who told the Globe and Mail, subsequent to receiving financial industry assurances, that management fees will be "substantially less" than they are for RRSPs? 1) Money will be locked into the PRPP unlike the RRSP. You may be able to switch between funds but the fact that the investment management company knows the money will not be withdrawn means less need for cash balances and less urgency for short-term return-chasing by funds that undermine returns. 2) Marketing costs, which are embedded into management fees could well be less since the target market for the financial industry is not the individual consumer but small and medium-size companies. That should mean no glitzy TV ads. There will be no trailer fees to salespeople (aka financial advisors); in fact, the draft bill specifically bans kickbacks by fund companies to employer sponsors (par.33). 3) The regulatory structure should help to control the most egregious overcharging. Good 'ole politics might even have a bearing since the Governor in Council, i.e. the government, gives itself the power to decide what "low cost" fees means (par.76 (1) (j)).

No, the PRPP will NOT help, it may even do harm.

• NoHype Investing author Gail Bebee emailed me her comments, which I think are spot on, so I'll simply reproduce them with my highlighting):
  

  "1. Employers are not required to offer this, or any other, employer-sponsored pension plan.

  2. Employees will be able to opt out at will.

  3. The financial industry, the same folks who charge Canadians some of the highest mutual fund fees in the world, will be managing the pension funds and will have a major say on the fees charged to do so.

  4. More government bureaucracy will be set up to regulate this new program.

  5. RRSPs already offer a similar retirement savings option. The issue is that not enough Canadians participate."

• Wealthy Boomer Jonathan Chevreau's comments in the Financial Post gave some nuance to Gail's points.
• The PRPP will complicate and confuse - The retirement landscape is already tough enough to understand, what with RRSPs, Defined Contribution and Defined Benefit Pension plans and TFSAs. Another layer of complexity is added. How will people make intelligent informed decisions about which to choose under what circumstances? There is no advice-giving component included in the PRPP structure. Blogger Preet Banerjee was right on the mark pointing this out in a CBC article on the announcement. With each province being required to implement its own complimentary legislation, it's a sure thing Canada will add another patchwork of permutations and combinations in rules, all of it totally unnecessary. What will happen when people move to different jobs in different provinces or with different companies? The minister says the plans are portable and transferable but sure as to betsy a lot of folks will end up with several plans. I already have two different LIRAs that cannot be combined (one is federal, the other provincial) on top of an RRSP and a TFSA. Another possibility to add?! Gimme a break!
• Low pay workers will likely get scr***d - Tax-wise, the logic of the PRPP will work the same as an RRSP. In a couple of posts here and here on the HowToInvestOnline blog comparing the TFSA and the RRSP for retirement savings, it is quite clear that anyone earning less than $37,000 is better off using a TFSA. If such workers get auto-enrolled into the PRPP and they don't opt out (who is to tell them to opt out except for lowly bloggers that they never read anyway?), they will be appreciably worse off in retirement. Thanks for your help, government!
  
• PRPPs pale in comparison to the CPP - The much debated alternative solution, that of expanding the CPP, as we have previously argued here and here, meets the criteria of what is needed much better. Over at Moneyville, author and pension expert Moshe Milevsky points out that the Pooled Retirement Pension Plan doesn't even live up to its name. It doesn't provide a pension - a lifetime of secure guaranteed income - at all, it is only a savings and investment plan that will go up and down with stock and bond markets.
  

Later addition: Commenter Leo's new blog PRPP Canada devoted to PRPP (the blog's mere existence is a sign of the additional complexity Canadians are soon to face) contains a link to lawyers McCarthy Tétrault's review of some of the ins and outs of C-25. From what McCarthy says, the law won't require that there be a default option if the PRPP offers a menu of investment (aka fund) choices that a "reasonable and prudent" person could use to assemble a retirement savings portfolio. That's one less small but critical nudge.

Education Savings Options: RESP, TFSA or RRSP?

Back in 2007 I compared the RESP and the RRSP as investment savings options for funding higher education, excluding the TFSA since it did not yet exist. The conclusion at the time was that the first $2500 of savings should go into an RESP to take advantage of the free money (courtesy of other taxpayers) available from the federal government in the form of the Canada Education Savings Grant. The $500 annual CESG (20% of contributions up to $500 per year and $7200 maximum lifetime - more details here from TaxTips.ca) made all the difference.

It's time to revisit the question. First, the TFSA now exists. Second, an anonymous comment this past July on the original post suggested the RRSP might be better if one takes into account the possibility that the student can transfer up to $5000 in annual tuition deduction during the time of eventual study, which gives the parent a 15% tax credit (i.e. $750) on the tuition transferred. Excellent question! With interesting results too.

I've built a downloadable spreadsheet (look for the download link on the right hand side of the web page once the spreadsheet opens up as a Google doc in your browser) for readers to play with beyond what I have already done.

Conditions Applied to My Analysis:

• Parent Must Have Enough RRSP Contribution Room - The whole analysis presumes you can put in $2500 per year new money plus up to $2100 reinvesting the tax refund each contribution generates, plus the reinvested refund on the reinvested refund, plus the reinvested refund on the reinvested refund on the reinvested refund etc ... (remember that child's song, there's a hole in the bottom of the sea? this is the tax refund version of it); that's why the RRSP part of the spreadsheet extends way out to the right. At the top Ontario marginal tax rate of 46.41% (see TaxTips.ca's tables for personal tax rates in each Province, which readers can use to check what happens in their own bailiwick) that means needing another $2100 or so of extra annual contribution room. Doing this gives the RRSP option its most favourable conditions.
• Only $2500 in Annual Contributions - This condition is to give the RESP its most favourable conditions, namely that it gets the most free CESG money, so that each contribution buck is getting the most bang.
• Child Must Not Have Enough Income to be Liable for Taxes during Higher Education Years - As I noted in the original post, the RESP's advantage disappears if the student has to pay taxes, even at the lowest tax bracket (see the Student_Taxable tab in the spreadsheet).
  

Results: (the summary numbers for the discussion below are in the Results tab and the calculation table with inputs you can use to plug in your own numbers is in the RESP_RRSP_TFSA tab; other tabs contain the calculation tables from the original post)

1) RESP is (Almost) Always Best ... if the Child Takes Post-Secondary Higher Education - No matter what the parent's tax rate, the RESP comes out ahead after tax, as shown by the green numbers. The only circumstance when it does not is when, as shown by the red numbers in the Results tab, the parent's tax rate at time of withdrawal is at least three tax brackets lower than at time of contribution - e.g. taxable income goes down from $100k to $70k as in retirement - and the investments earn a low (2%) to medium (5%) annual return. In this latter case, the RRSP wins, but not by much.

2) TFSA Wins if the Child Does Not Attend Higher Education and Parent's Tax Rate Stays the Same - The green numbers under TFSA show that no matter what tax rate the parent is in and regardless of investment returns, the TFSA does better, but not by a lot, than both the RESP and the RRSP.

3) RRSP Wins if Child Does Not Attend Higher Education and Parent's Tax Rate Drops at Withdrawal - The green numbers in the RRSP column show that the RRSP does better and better the more the parent's tax bracket drops between the date of contribution and withdrawal. The higher the investment return, the bigger the effect. When it is three brackets lower and there are high (8%) returns, the net difference is $25,000 more than the RESP and $15,000 more than the TFSA.

Bottom Line:

• if you are confident that your child will go to college/university before you retire, put that first $2500 into the RESP; if you have several kids, the chances should be higher that at least one of them will go on.
  
• if you really are not sure your child will go on to higher education , then the RRSP is the better hedging option. The TFSA's advantage when the child does go on isn't big enough to offset the TFSA's lower results compared the RRSP when the child does not go on. Also in the RRPS's favour is that the RRSP's disadvantage compared even to the RESP when the child goes on is much less when investment returns are low and you are in the lower tax brackets.
  
• if you believe that your income will drop two or more tax brackets by the time the higher education decision will need to be taken, the RRSP looks better even than the RESP. When there is no higher education the RRSP is always superior to the RESP and even when there is higher education, at two brackets lower you are ahead except at high investment returns. If your investments within the education account are cautious and low risk, low to medium returns are what you will get.
  

One Investor's Wish List for the Canadian Election

Rob Carrick of the Globe and Mail published his wish list to politicians in the current Canadian election, so here is mine.

1. Expand the CPP by increasing pensionable earnings limits and raising contribution rates to target a 40% income replacement rate. If I could only get one wish, this is it. It is the best solution by far for what retirees need and in comparison to present alternatives or to the proposed PRPPs.
   
2. Triple the annual TFSA contribution limit ... ok, I'll compromise with doubling it. It is a simple, understandable, effective multi-purpose account but the $5000 is too little.
3. Start selling Real Return 1-5 year maturity Canada Savings Bonds as I wrote about here. Retirees without inflation-indexed DB pensions need them. That might reverse what the Globe recently described as their "long slow death".
   

Senate Weighs in With Some Useful Retirement Savings Suggestions but ...

Canada's Senate committee on Banking, Trade and Commerce announced a half-dozen recommendations on how the government could enhance retirement savings in its Oct.19 report Canadians Saving for Their Future: A Secure Retirement.

The recommendation that would likely have the most beneficial effect is the suggestion to establish a Canada-wide plan for retirement saving and investing. The new plan would entail setting up five or so professionally-managed, competitively-sourced investment funds into which savings deductions/contributions of Canadians 18 and over would go. It's a pretty good but incomplete plan. Why?

1. Auto Enrollment - the report calls the plan "voluntary" but that means an optional opt-out, which few people will do. As the famous book Nudge explains (and as the use of the word in the report slyly suggest that the Senate committee is aware of the idea), the difference between voluntary opt-in and opt-out is huge and participation rates will be as good as universal, up in the 90+% range. Goodbye to the costly sales and marketing overhead cost of retail funds because it's a captive market.
2. Fiduciary Duty Governance and Management and Competitive Sourcing - they call it a commitment to avoid "real and perceived conflicts of interest". Professional managers can add diversification, discipline and net value when the fees they charge are restrained - i.e. the gross investment return isn't sucked dry by the fees. Hello to much lower fees from the powerful negotiating position that such a massive plan will have and hello to a resulting much higher net return to investors with much higher end value retirement savings.
   
3. Optional RRSP or TFSA - it is valuable to have the flexibility of being able to contribute to the right account for one's tax situation / income level (the familiar question about whether your tax rate will be lower in retirement - RRSP better, or whether your absolute income is low - TFSA better) and retirement goal (if legacy desired, TFSA better).

The report does not address a few key issues related to this idea:

• Savings Deduction Rate? - how much should it be? Maybe 9% would do, the same as for CPP, which aims to replace about 25% of pre-retirement income, so such a contribution rate in this plan would provide another 25%. A less desirable method would be to allow the contribution rate to be chosen by the contributor but then the new plan should have a default rate with option to change it (another nudge).
  
• Sequence of Returns Risk - the danger of a market plunge, such as happened in 2008, at the intended time of retirement is that the total available to purchase an annuity is vastly reduced and permanently low retirement income would result. The alternative of withdrawals from a RRIF would see much lower sustainable withdrawals. Of course, nobody would retire after a market crash if they possibly could and they would deal with the market returns risk by continuing to work however long it took for market and retirement savings recovery. That's not the only way to deal with this risk though. The method of the CPP is to have a defined benefit payment coming no matter what the state of the market - did the CPP announce a reduction of payments in 2008 even though its investment portfolio dropped about 20%? The reason the CPP can maintain payments is that it can, as a fund with a very long term investment horizon, smooth out market humps and bumps, knowing that savers continue to provide cash inflow. There is time risk sharing going on within CPP that the Senate's proposal lacks, which to my mind is a very important feature of making retirement saving feel secure and actually be so.
• Conversion to Retirement Income, Inflation Risk, Longevity Risk and Annuities - a retirement savings plan, such as the one proposed, must be converted into an income stream and the report does not consider how this will be done, except for brief off-hand references to buying an annuity. Yet the income conversion vehicle, its cost and its effectiveness in countering inflation and longevity risks determine the success of the whole retirement income exercise. This cannot be considered apart from the savings phase method with the assumption that all will be well. Choose an annuity and even low, normal 2% inflation eats away a huge portion of the value of a fixed payment annuity over the longer and longer retirement periods of today. Real constant-value CPI-adjusted annuities are almost absent from the Canadian marketplace. Most annuities on the market in effect provide income for life at a fast (high inflation) or slow declining standard of living. I bet that's not what people want or need. There is also the problem that the market is lop-sided - the people who want to buy annuities are those who figure they will live longer and not those who will die off sooner and whose cash helps maintain a higher standard of living for the survivors. (Those who believe this is unfair could be reminded that sharing the risk means everyone gets higher payments than if no one shares) The annuity-selling insurance companies know about likely-to-live longer annuity buyers of course, and so annuity payouts are even lower. Contrast that with CPP where everyone, early and late deceased, automatically and without choice to opt out, gets into the annuity payment stream. Choose the other option to generate income, a RRIF from which withdrawals are taken, people have the very hard job to figure out how much to withdraw given their uncertainty how long they will live and need income. Live too long and you run out of money. There is no longevity risk sharing. People can either be very cautious, withdrawing slowly, and perhaps live a much more restrained lifestyle than they might have liked, or they can live high, perhaps to discover that they must drastically reduce their spending later on. Pooled assets with no opt out (i.e. with longevity risk sharing) during withdrawal means higher payments for everyone and much less worry along the way. The prime example of a successful end-to-end solution is the CPP - you pay in a certain amount per year and you are guaranteed (by the most stable provider around, the Federal government) a certain inflation-adjusted amount for however long you live.

The report includes several other worthwhile but less significant suggestions:

• Set a TFSA lifetime contribution limit of $100,000, which could be used immediately in full any time e.g. for an inheritance; helps present-day retirees with taxable accounts
  
• Remove the effect of RRSP withdrawals on means-tested benefits; makes things less complicated and less punitive
  
• Defer RRSP conversion age to 75; helps those who work longer
  
• Have the Financial and Consumer Agency of Canada do financial education and monitor investment advisors (I think they mean financial advisors, which is much broader than investment advisors) - pretty wimpy, they could and should have recommended that fiduciary duty for financial advisors be put into law with some body given policing powers
  

Tax Free Savings Account: a Clever or a Fortuitous Name?

In the book Why Smart People Make Big Money Mistakes by Gary Belsky and Thomas Gilovich, the authors note an interesting quirk - when people receive "bonus" money, they are prone to spend it right away, while "rebate" money gets saved. Another book, Nudge, written by Richard Thaler and Cass Sunstein, recommends that governments exploit such thinking processes to influence people in the right direction (which in itself can be debated, though they follow a reasonable principle that the person him/herself would need to be in agreement that they are being nudged in a way that they themselves think beneficial).

Enter the Tax Free Savings Account (TFSA), introduced by the federal government in January 2009. Its purpose is to encourage people to save. Sounds reasonable for people to save before spending, rather than the reverse. So, I wondered whether the feds got the idea for the name with the intention to virtuously manipulate our behaviour. I asked the Department of Finance and this is what they said: "The name – Tax Free Savings Account – was considered to best represent the nature and benefits of this account ..." i.e. no nudging happened here, just routine, bureaucratic, mundane, literal, factual thinking. To put it in terms of a previous management trend, they were thinking fully inside the box. Or, that's what they are willing to admit, because though they considered other name options, they wouldn't tell me what they were. Governments routinely and deliberately mislead us (in our own best interest, so it is said) but cannot admit to doing so. Guess we'll have to guess whether this was a case of Nudge or Nudge Nudge Wink Wink.

The TFSA has enjoyed rapid uptake. Perhaps some of it has to do with the name itself? First, the word "free" is a sure-fire consumer salivation-inducing tool that works no matter how much it is misused and abused in advertising. Second, savings is a good trigger-word to induce people to put money in and to keep it in. Imagine if they had called it the Tax Free Spending Account.

It would be useful for the feds to track withdrawal rates to see if they stay low, and perhaps to do surveys to ask people what they used the money for when they did withdraw it. If the program works, we should expect to see people withdraw little for luxury consumer spending (the new plasma TV, a holiday trip) and more for things with long term value (house, education).

New Data on TFSA vs RRSP and Canada's Rube Goldberg Tax System

Cartoonist Rube Goldberg was famous for his drawings of incredibly complex, convoluted machines. That's Canada's income tax system. A new paper from the CD Howe Institute Saver’s Choice: Comparing the Marginal Effective Tax Burdens on RRSPs and TFSAs (kudos to Don Cayo of the Vancouver Sun on whose blog I found the link) reveals the gory detail of the complexity created by the interaction of all the start and stop levels of tax credits, tax brackets, tax surcharges, rebates and clawbacks. The table they show for an Ontario taxpayer has no less than 33 income levels at which tax rates either go up or down. Contrary to popular belief, the tax you pay on your next dollar of income, the marginal rate, does NOT go up constantly and smoothly. It bounces up and down by more than 100% for very small rises in income. These tax items are not special rules for individuals in unique circumstances, it is what everyone faces.

What's more, and what is important for the average person trying to decide whether to put savings into a TFSA or an RRSP, as a result the better choice flip-flops back and forth between TFSA and RRSP. The answer varies by: Province, by income in retirement compared to during working life (the replacement rate) and by working life income level.

CD Howe's Findings

• $20-30,000 or so working income, TFSA always is better and by a massive amount, the GIS clawback being the primary cause as TFSA withdrawals are not included as income for the calculation while RRSP withdrawals are included.
  
• $35-45,000 or so working income, RRSP is better but not by nearly as much as the TFSA advantage in the bullet above
• the boundary between TFSA and RRSP shifts higher as retirement income replacement is lower e.g. in Ontario, at 80% retirement replacement, the TFSA is better up to around $30,000 working income but at 60% replacement, the TFSA is better up to about $39,000
  
• TFSA is better across most of the working life income spectrum for Alberta and Quebec and most income replacement levels
• most surprising, TFSA is everywhere best for the highest income earners of $110,000+ even when their income replacement is only 60% - one would have thought they would end up in a much lower tax bracket and thus conform to the general principle that RRSP is best when your tax rate is less in retirement.
  
• above low income levels, the advantage for TFSA or RRSP is not enormous (less than 10%+/- in marginal tax rate), except for huge spikes up or down in Ontario
  
• a change of only a few thousand dollars in working income can shift the balance, sometimes drastically, from TFSA to RRSP or vice versa, especially in the band $35,000 up to about $80,000 in Ontario (which leads me to conclude that Ontario residents face the most uncertain, difficult and chaotic tax system as far as TFSA vs RRSP planning goes)

Ontario residents in the income range from $35,000 to about $90,000 probably need most to hedge their bets about where their retirement tax rate will end up and to contribute to both their TFSA and RRSP. At least both benefit from the powerful advantage of tax-protected compounded growth while funds are in the plan.

Unfortunately, CD Howe only looked at the numbers for Ontario, Alberta and Quebec, so taxpayers in other Provinces must be wondering where they stand. Don Cayo got preliminary data from CD Howe about BC, which he says is similar to Ontario.

The Federal government could do us a favour by expanding TFSA contribution room to make it equal to the RRSP, or make it a combined total that people can divide between the two as they choose.

TFSA Account Adoption Creeping Steadily Up

RBC has just released a survey that shows the number of Canadians opening TFSA accounts is climbing steadily and is now at a quarter of eligible (18+) Canadians. Back in April Jonathan Chevreau had reported in his Wealthy Boomer blog that 20% had opened accounts to that point. The good news is that most people - over 70% - are mostly aware of the TFSA. Hopefully, the slow to act will soon join the list ... hint to some members of my family!

It was a wonderful coincidence that the January 1st start-up date more or less marked the bottom of the equity slump so those who were quick to jump in have seen a very healthy return so far - my initial $5000 evenly split between XIU and XMD has risen 33% or so since my account opened in February, a great tax-free return.

Maybe more Canadians should be a little more adventurous than the cash savings and the GICs that dominate TFSA account holdings according to RBC. Interest rates are so low that there isn't much point to tax-free savings if there isn't any income generated. RBC's headline to its press release - Why aren't Canadians taking advantage of tax free savings accounts? - is true in more ways than one.

Government Ban on RRSP - TFSA Swaps Revisited: One Red Herring and the Real Problem

Sometimes I'm a bit thick and it takes a while for the real reality to distinguish itself from the illusory reality.

The Illusory Reality: Yesterday I noted the scenario mentioned by two other bloggers - see here and here - for supposedly moving funds tax-free from an RRSP to a TFSA. The illusion is that the investor moved funds but what has actually happened is that the investor made a profit on an investment in the TFSA account and made a loss in the RRSP account. To see this, it is only necessary to remember that the exact equivalent result could be achieved by simply buying and selling on the market instead of doing a swap. In fact, a swap is just that - instead of the investor buying or selling on the open market, his accounts buy and sell to each other.

Another tack is to think of it in the investor's shoes - after the stock price rises in the TFSA, you are $XXX better off in total wealth. Would you really want the stock to decline after your RRSP buys it so that the TFSA can buy it back? After the round trip of swaps and the stock decline, the investor has less money in total than after the TFSA made a profit. The TFSA is the same but the RRSP is worse off. In any case, there is no guarantee that the stock will happily fluctuate up and down within the range needed to come out ahead on a net basis. That's why day trading is a highly risky proposition.

This non-problem is a manifestation of the sunk cost fallacy. At each step of the process, the investor is faced with a clean slate and a new decision about how to invest. The past, however recent, is irrelevant. I certainly hope the Department of Finance policy is not meant to stop this kind of investor operation because the government would then be taxing the profits of normal risky stock purchases and sales.

The Real Reality: The real problem is revealed in the discussion on the Financial Webring TFSA thread. It is the fact that the tax rules allow an investor to choose which price within a security's trading range on the day of the swap to have applied to calculate the value of the swap. The difference between the high and low price is what generates the tax-naughty riskless profit for the investor who has eliminated the market risk through judicious use of options. A more volatile stock, or a volatile day to perform the swap, is better because it produces a higher high-low spread and that increases the risk-free profit. Options also use less capital than straight stock, which boosts the returns.

That being the case, the Government would seem to be engaging in throwing out the swap "baby" with the dirty hi-lo price "bathwater". Instead of banning swaps (which doesn't make sense anyway since direct stock trades can effect the same outcome) or changing the rule that any price during the trading day when the swap takes place may be used to value the transfer amount, either declare that two-way swaps of the same security will automatically be valued at the same price within the same day, or perhaps within 30 days in a manner akin to the superficial loss rule. There's even a catchy name to give it - the superficial swap rule.

TFSA Ban on Asset Swaps with RRSPs

Updated later in the day - see red text.
The proposed new rules to eliminate potential abuses of TFSA accounts announced the other day by Finance Minister Flaherty includes one strange rule (see the Department of Finance's Backgrounder section on Asset Transfer Transactions) that bans swaps between TFSAs and registered accounts like RRSPs, LIRAs, RRIFs.

I must admit I was puzzled since I had not previously seen anyone proposing a way to avoid taxes by doing a swap.

There seem to be several explanations of what the rule prevents:

1. A visit to the Financial Webring where all the usual suspects gather and gleefully point out such tax "work-arounds" uncovered in a TFSA thread a post by Marty123 on Oct.20th detailing a highly sophisticated strategy using massive over-contributions and options.
   
2. Blogger Michael James on Money's post TFSA Abuse shows another scheme that seems to fit the bill.
   
3. The Canadian Tax Resource blog gives a similar example to Michael's.
   

Perhaps it is the space limitations of traditional media but the clear online examples put to shame the ambiguous description in the Globe and Mail article on the subject.

My direct question to the Department of Finance for an example has yet to be answered (stay tuned for what they eventually tell me). Here is what they said: "The idea would appear to be that overall, advantage is rarely gained but the scheme is such that a large number of small swaps, particularly involving volatile stock, could enable capital gain to exceed tax liability, using financial software and hedging strategies."

In this first year of the TFSA when the contribution limit is only $5k, it is likely Michael's strategy would hardly be worth it considering each swap is charged a fee by the broker ($45 flat fee per security swapped at my discount broker) and it would eat up much of the tax savings. However, down the road when accumulated TFSA room gathers bulk, the benefit becomes more attractive.

Yet to be confirmed also is the import of the tax penalty. The Department of Finance phrase is: "TFSA amounts reasonably attributable to asset transfer transactions will be taxable at 100%." I would think that what it means is that you would be taxed on whatever "excess" you had managed to transfer - the $1000 in Michael's example - at your normal marginal tax rate i.e. just as if you had withdrawn the $1000 directly from the RRSP, and not at a 100% tax rate, which would amount to confiscation by the government of the excess shifted, an action that even for the government is a tad harsh. " Update: I was wrong, ouch! quote from an official spokesman of the Department of Finance - "No it’s not the marginal rate, it’s a levy of the full amount of the *gains*. It won't matter much anyways since the brokers will all block any sort of swaps with TFSAs and registered accounts.

I wonder if the government will now ban swaps between locked-in registered accounts and non-locked-in registered accounts since the same technique Michael describes could be used to move value and unlock locked retirement money.

Students and Low Income People - for TFSA's Sake, Make Sure You File a Tax Return

The new Tax Free Savings Account allows any Canadian over 18 to contribute up to $5000 per year into an account whose earnings are completely exempt from tax. The $5000 contribution room accumulates with every year, whether you use it or not, so even if you are not able to contribute this year, down the road when your income increases or your expenses drop and that becomes possible it is very worthwhile to have those yearly $5k amounts built up.

But how do the government tax people at the Canada Revenue Agency monitor and police who has the contribution room each year? The answer is provided by D&H Group Chartered Accountants in their 2008 Year End Tax Planning Tips:
"With the new TFSAs, it is important that all individuals who are 18 or older file income tax returns even if they do not have any income because the Canada Revenue Agency is tracking TFSA contribution room only for individuals who file income tax returns."

Is the RRSP Refund as Contribution to TFSA Dipsy-doodle Worth It?

Some commentators have suggested the best way to solve the conundrum of deciding whether to contribute to an RRSP first or a TFSA is to make the RRSP contribution then use the tax refund to put into the TFSA.

Does this make sense? On first glance, one gets the impression that more is being protected from tax. For example, if you put $1000 into an RRSP and are in a 40% marginal tax bracket (despite the fact that no such tax bracket exists, it is convenient to use a round number for illustrative calculations), you get 40% x $1000 = $400 back, which can be put into a TFSA, which seems to result in a total of $1400 being "saved" while a straight $1000 in a TFSA produces no tax refund and so only $1000 is set aside.

The answer is that you are no better off doing the RRSP refund into TFSA than the straight TFSA contribution if you stay in the same tax bracket when you withdraw the RRSP money. Save yourself the trouble. Want to see the numbers? Look at the table below where I've worked through a simple example.



There are other factors to consider in deciding between the TFSA and the RRSP, most of which come out in favour of the TFSA as various people have said like Ed Rempel on MoneyvsDebt.com and on Million Dollar Journey. The one thing that still goes in favour of the RRSP is when your tax rate upon withdrawal will be lower than at contribution. It may still not come out in favour of the RRSP if you lose income-tested benefits like OAS and GIS. Taxtips.ca has a handy calculator in which you can plug in numbers to test RRSP vs TFSA with differing tax rates and considering the OAS and GIS clawbacks.

Questrade for my TFSA: the Sign-Up Experience

I've now signed up for my Tax Free Savings Account with discount broker Questrade and am happy to report so far almost everything is as good or better than I hoped.

Pluses

• Fully online account sign-up - For those who are out of the country a lot, as I am right now in the UK, it is a relief and a pleasure to be able to do online the whole sign-up, including form filling, "signing" agreements, providing ID by email (a scanned passport or driving license). No paper to send in Hooray!
• Electronic money transfer from my bank account to Questrade via the Pay Biller service to make the $5k TFSA contribution (or if I was to need it, to move money back)
  
• Rapid personal email confirmation from the the new account manager Emil Vojkollari, whose name and number I now have in case I need it!
• Quick human contact to a rep through the 1-888 number when I had a question about the only negative below

Minus

• Multiple named beneficiaries for the TFSA is not yet possible on the electronic form; you must post a letter in with instructions - names and proportions to each beneficiary. BTW, why is the province of Ontario lagging others like BC, AB, NS and PEI (according to accountant Dean Paley writing in Jonathan Chevreau's column on the Three Big TFSA Issues) in passing legislation allowing such named beneficiaries to be direct recipients of a TFSA proceeds upon death instead of having this pass through the will/estate and incurring probate taxes?

Why did I pick Questrade?
They are the only brokers who offer more or less complete ability to set up ETFs to automatically reinvest dividends/distributions and without extra commission as I wrote about in DRIPing ETFs in Canada. (Actually, Qtrade will also DRIP ETFs but they don't offer a TFSA) For me, the TFSA is not an emergency funds account, it is just another part of my investment portfolio which consists primarily of ETFs, and that's what I want to buy at Questrade. Given that the TFSA limit is only $5000, the distributions will be small and it would be too costly to buy a couple of shares at a time so the cash would just be sitting there idle without Questrade's unique free service.

Fees and Deals on TFSAs at Banks and Discount Brokerages

The TFSA starts January 1st, 2009 and it's time to pick one. But as usual, though the tax rules are the same for all the way each bank and broker implements and charges fees can vary. Rob Carrick warned about fees and provided some numbers in this Globe article. CanadianCapitalist summarized the range of options for TFSAs in this post.

Being the type of guy who always wants to compare options and find the best deal I have taken Rob's work a little further and done some browsing and phoning to make up a little spreadsheet that shows what I have found. Given the sorry state of information flow within large financial institutions to both customer service reps (a blogger does not have access to the insiders with the exact knowledge or authority so one gets the "real customer experience" in trying to dig up information) and websites, some of this info may not be correct.

The Best Deal in my opinion is .... Outlook Financial's 5% 5-year cashable GIC. When I phoned earlier today the rep assured me that one can lock in the rate today even though the money can only go into the account as of the legal start day of January 2nd. The astute will observe that Outlook has an ad on my website so you can be sceptical about my motives for recommending them but I invite you to try finding a higher GIC rate. Go to Canoe.ca Money Rates for GICs do the sort from high to low and Outlook's is the highest in Canada bar none. The only slight downside is that the guarantee for payment of principal and interest comes not from CDIC but from the Credit Union Deposit Guarantee Corporation of Manitoba. If the CDIC safety net is a requirement for you, then National Bank's 4.1% 19 month GIC looks attractive, as does Bank of Montreal's 4.3% 3-year promotional offer.

The bottom line for the discount brokers is that there is little to distinguish them with respect to TFSA alone. My own broker BMOIL is the only real outlier with a fee of $25 per withdrawal. The big drawback for all the brokers is the presence of hefty $125-135 fees for transferring an account to another institution. Among the things to consider:

• account opening hassle involved for each institution - e.g with BMOIL, even as an existing client, I would need to send them my ID info again (and I read similar comments about TD Waterhouse on the Financial Webring thread on TFSA Offerings), which is no easier than Questrade, where I don't have an account and which said I could simply mail them a blank cheque from my bank to comply with the money laundering regulations.
• trading commissions and fees - see discount broker Trading Commissions at StingyInvestor
• overall reputation - see the Globe and Mail's annual broker ratings

Some brokers are not even offering TFSA accounts, like QTrade rated #1 in the Globe ranking or E*Trade (that's why they aren't on my spreadsheet). CIBC Investor Edge's offering is coming "March-April" 2009 while ScotiaMcLeod Direct will only have application forms ready (and confirmation of fees) on Dec.22nd.


Whatever you do, go open a TFSA as soon as possible, especially before the unholy alliance of Libs/NDP/Bloq gets into power and starts reversing the "errors" of the Conservatives. Who knows how long the TFSA might last.

Credential Direct's Great Guide to Using The TFSA

The best explanation I have yet come across for how to use the new TFSA is Credential Direct's brochure. In 12 big print pages, complete with yellow smiley faces, it clearly and simply explains when to put money into a TFSA or an RRSP/RRIF, and at what ages and stages of life - start of career to home buying to education to after retirement - to use each.

Hooray for TFSA! Canadian Federal Budget Delivers on My Wish List

Well, you read it here first on my Christmas Wish List 2007. Minister Flaherty has delivered on my request to institute a tax-free savings account just like the ISA that exists over here in the UK. Wonderful. These accounts are so simple and straightforward, they achieve much better than RRSPs the goal of getting people to save. There are no books written about ISAs, unlike the tome Preet Banerjee recently put out about RRSPs, because there's so little to write about. The worst thing about the new accounts is their awful acronym - TFSA. How the heck do you pronounce that - TaFSA? Didn't they learn with RRSP, where is the marketing savvy?

The $5,000 annual contribution limit is too low; better would have been double that and even better would have been four times higher, which would start killing off RRSPs. The "if you don't use it, you don't lose it" feature of the annual contribution limit is a great measure for added flexibility since many families with young children might not get the chance to save for a number of years.

I'd expect the new TFSA, as the info sheet suggests, to be heavily used by seniors, for instance for funding inheritances. The money can be put aside, grow tax-free and be non-taxable at death. While it is in the TFSA, it can serve as a safety cushion for unexpected health care costs and if not needed, passed along to the next generation. Increasing life expectancy could allow amassing a tidy sum.

In short, I believe the info sheet blurb is not too far off (except for the niggardly $5k) when it says "It’s the single most important personal savings vehicle since the introduction of the Registered Retirement Savings Plan (RRSP)."

It was nice to see our government paying attention to this humble blogger. I suppose they are waiting for the next budget to put in an annual tax-free capital gains exemption.