January 2009: by Jos Herman

Stop paying the tax on your investment income

2009 marks a new era with the introduction of a Tax-Free Savings Account. I cannot recall the number of tax returns I have seen that show interest income... and where from?

Non-registered investments such as high-interest savings accounts, GICs, bonds and other interest bearing vehicles. What happens on your tax return? The interest that has been earned throughout the year must be reported and is fully taxable. This tax erosion of your investment cannot be overlooked.

In your financial plan, you should look for opportunities to be tax efficient with your investment income. With that in mind, the new Tax-Free Savings Accounts (TFSAs) should not be overlooked.

Much like when the RRSP program started in 1957, Canadians are still uncertain of what this TFSA savings vehicle is and why they should care. Effective January 1, 2009, Canadians could start contributing to the program implemented by the federal government in this last budget. Think of the TFSA much like you would an RRSP or RESP.

Investments held within the account grow tax-free, meaning that there is no tax on interest, dividends or capital gains earned on investments within a TFSA. TFSAs can hold:

• mutual funds,
• segregated funds,
• stocks,
• bonds, and
• GICs.

However, a TFSA offers greater flexibility. Here's why:

1. You can contribute up to $5,000 for you and your spouse and it is indexed for every year thereafter.

Why is this important? If your investment strategy includes holding interest bearing accounts like a GIC or high interest savings account, this year alone you could potentially shelter $10,000 for you and your spouse, and save up to 44 per cent in tax on the investment income year after year.

2. Contribute and save during your lifetime and income split.

Why is this important? Based on the rules set by CRA, you can continue to contribute during your lifetime. Because there is no age limit for TFSA contributors, Canadians can transfer funds into a TSFA well after the RRSP age limit of 71. Furthermore, you can provide funds to your spouse/children/grandchildren (over 18 years old) in order for them to contribute to their TFSA without being subject to income attribution rules.

3. You can withdraw funds from the TFSA at any time for any purpose.

Why is this important? As you save over the years, you can withdraw it for medical expenses, vacations, etc. Any amount withdrawn from the account is automatically added back to your contribution room for the following year. There are no restrictions as to what those funds are to be used for. You have control of your money. If you later withdraw $50,000, you regain that same $50,000 in contribution room.

So here are some practical examples of having another type of investment vehicle such as a TFSA. You may be a high income earner that has maxed-out your RRSP contribution room or you participate in a registered pension plan (RPP). In order for you to save additional funds for your retirement, your option is usually to place your savings in a non-registered account that may be exposed to tax. The TFSA provides a tax-sheltered option for you to continue saving.

Let's move you forward in life to the point of retirement. You have contributed to RRSP's over the years and received the tax deduction with your contributions.

Now, CRA is knocking on the door to collect on the tax. The income received from your RRSP's, RPP's, etc. is fully taxable. CPP and OAS income are also fully taxable. In order for you to maintain your standard of living during your retirement years, you want to ensure that you have created a tax-efficient investment in which to pull retirement income. So, perhaps learn a new acronym - TFSA.

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About the author
Jos Herman, CA, Financial Advisor, is part of the advisor team with
Regency Advisory Corporation. She can be reached at 665-3377 or 1-877-837-3377.

Disclaimer
Please contact a professional advisor to discuss your particular circumstances prior to acting on the information above. The opinions expressed are those of the author and not necessarily those of Assante Financial Management Ltd.

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