$10,000 TFSA limit: what it means for clients

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Investors who put the full $10,000 a year in a TFSA will save $3,708 in tax over 10 years — a 12% increase in after-tax investment income, based on a 5.5% rate of return— compared to saving $5,500 in a TFSA and $4,500 in a non-registered account.

The government has decoupled TFSA limit increases from inflation, meaning any further increase to contribution limits will have to be legislated.

Eligible clients who have not contributed since the TFSA’s creation in 2009 now have $41,000 in contribution room. Carol Bezaire, vice-president of tax and estate planning at Mackenzie Investments, says CRA won’t penalize anyone who adds another $4,500 to their TFSA after April 21, 2015, even though the budget hasn’t technically passed yet. That’s because CRA considers the budget’s pronouncement law. On April 23, CRA confirmed to Advisor.ca that clients can access the expanded contribution room now.

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Canadians in the middle tax brackets, making about $50,000 a year, probably won’t be able to save more than $5,500 anyways, says Doug Carroll, vice-president of tax and estate planning at Invesco. That’s because at that income, a $5,500 contribution represents about $8,500, or nearly 20%, or someone’s pre-tax earnings, he estimates.

But for other reasons, the increase helps lower-income and wealthy clients alike, says Darren Coleman, portfolio manager with Coleman Wealth of Raymond James.

“The good news about the high limit of the TFSA is it gives us so much more creativity in terms of how we can be planning for clients,” he says.

In 2013, 11 million people had opened TFSAs and 1.9 million people had hit their contribution limits.

For clients making less than $50,000, the extra contribution room could make TFSAs preferable to RRSPs, Coleman says, because RRSPs aren’t as tax-efficient for people paying less tax.

“If you’re in a lower tax bracket when you put the money in, you don’t get much of a tax savings and you could actually wind up paying more tax when you take it out in the future,” he says.

Clients nearing retirement will also benefit from the increased limit, says Coleman.

“The traditional wisdom has been to leave the RRSPs for as long as possible before making withdrawals to continue the tax deferral,” he says. Now some clients could benefit from withdrawing the money earlier and moving the proceeds to a TFSA.

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“That way, we average out the taxation on the RRSP withdrawals over a longer period of time, and therefore pay less tax on the withdrawals,” he says. “A larger TFSA limit allows us to make better use of that strategy.”

Wealthier clients, who have likely contributed the maximum $36,500 under the old limit, can now start moving non-registered investments into their tax-free accounts. Whether or not investments should be moved over depends on how much they’ve increased in value, and when the money is needed, says Coleman.

“We want to move investments that are interest-bearing,” he says, because interest is taxed at the highest rate. “Or alternatively, we want to put in investments that don’t have much of a capital gain,” he explains, to avoid a current tax hit upon withdrawal.

“It also depends on the holding period, because if we have a capital gain, but we still plan on holding that security for a long time, sometimes it’s better to pay a little bit of tax early, so we never pay tax on it again.”

Moving non-registered money into a tax-free account allows advisors to manage investments more effectively, Coleman adds. Sometimes investments are left too long because investors are reluctant to trigger capital gains.

The increased contribution room will cost the government an estimated $1.1 billion in reduced taxes by 2020.

In the weeks leading up to the budget, the government signalled it would follow through on the promise, which the Conservative Party first made in the 2011 election.

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