Ed Rempel (CFP/CMA) is back!  This article will pit the new Tax Free Savings Account (TFSA) against the old school RRSP with the main focus being the potential GIS/OAS clawback during retirement.

“The future ain’t what it used to be.” – Yogi Berra

Tax Free Savings Accounts (TFSA’s) were just announced in the recent federal budget. At first, it seemed they would be not nearly as useful as RRSP’s since there would be no tax refunds for contributing. However, we are starting to analyze TFSA’s and it seems they beat RRSP’s most of the time. Credit Stephen Harper for implementing what may eventually become the most effective retirement savings vehicle for many (perhaps most?) Canadians, as well as a very useful tax saving tool.

To understand why TFSA’s will beat RRSP’s as a retirement savings vehicle for many Canadians, we first need to understand income tax on seniors.

TFSA’s appear to be almost exactly the same as RRSP’s, except without the tax refund on contributing and tax on withdrawals. Therefore, to determine whether TFSA’s or RRSP’s are better for you depends mainly on your tax bracket when contributing (during your career) vs. your tax bracket when withdrawing in retirement.

A common part of retirement planning and one of the main benefits of RRSP’s includes the assumption that most Canadians will be at lower income tax rates after they retire than they are during their working career. This may sound logical, but it is often not true. In fact, on average, when you include clawbacks on several programs for seniors, income tax rates on seniors are almost 50% higher than on adults under 65!

Our Canadian outlook of always looking after the have-nots has led to quite a few benefits for seniors that are clawed back based on income. The idea is that those with a lot of income do not need the tax relief. The end effect, however, is very high rates of income tax on seniors.

The 3 main Clawbacks that affect seniors are clawbacks on the Guaranteed Income Supplement (GIS), the age credit and on Old Age Security (OAS). GIS is a supplement of up to $7,608 of tax-free income paid to seniors with an income under $15,240. Essentially, for every $2 of taxable income, the GIS is reduced by $1. The age credit is a tax credit of $5,177 that is reduced by 15% for any dollar of income above $30,935. Maximum OAS is a taxable income of $6,028 that is also reduced by 15% for incomes above $63,510. (The OAS clawback is not quite as bad, since we at least get credit for the income tax we would have paid on the OAS.)

There are also clawbacks that apply to adults under 65, such as employment insurance and the child tax benefit, but none of them apply to everyone at any given tax bracket.

When you add the clawbacks that affect seniors, here are the approximate marginal tax brackets in Ontario for adults under 65 vs. seniors. The marginal tax rates apply to everyone, while the tax rates with clawbacks apply specifically to anyone 65 and over.

(Click for larger image)

Here is an updated table for 2010 that fixes a few errors.

Note that the average tax rate on seniors up to $121,000 on income (the start of the top tax bracket) is 45%, compared to 32% for adults under 65. This is a difference of 13% of income, or a total of 43% higher tax to pay for seniors!

Note also that seniors making under $15,000 or over $37,000 are almost all taxed higher than the top tax bracket of 46% for non-seniors!

The lowest tax rates for adults under 65 are on eligible dividends. In fact, the tax rates are negative at a few tax rates, but this is now being eliminated by 2010. The latest budget has increased income tax rates on dividends, which appears to increase them to no lower than 0% at any income level. So the marginal tax rates on most dividend income will be a bit higher than on this chart by 2010.

The lowest tax rates for seniors, however, are on capital gains. This is because the clawbacks are on taxable income – which is only 50% of capital gains but is 145% of dividends. For example, for seniors with no other income, the 50% GIS clawback is only a 25% clawback on capital gains income, but is a 73% clawback on dividend income.

Is there logic to these tax rates? Why should dividends have the lowest tax rate for adults under 65 who are building retirement assets, while capital gains have the lowest tax rate for seniors trying to get an income from their investments? It sounds backwards, but there is some logic when you understand the way CRA structures tax on investment income.

Many Canadians, if they have saved a good nest egg or have a decent pension, may be retiring on incomes of 50-70% of their working incomes. For example, an average Canadian may earn $50-60,000/year during their career, which would put them into a marginal tax rate of 31%. When they retire on say $30-40,000, they would be at a marginal tax bracket of 37% – which is higher than during their working career.

Note that many seniors will be at lower tax brackets in retirement, however. This is because most Canadians, if they have only modest savings for retirement, will likely be retiring with incomes of only $15-30,000/year, which would put them in the lower 22% tax bracket.

All of these tax brackets are adjusted for inflation each year. This means that the income amounts for each bracket will be close to double the figures in the above chart in 25 years.

What does all this mean for the usefulness of Tax Free Savings Accounts (TFSA’s)? That will be the subject of our next article.

photo credit: Marcin Wichary

77 Comments

  1. cannon_fodder on November 6, 2008 at 6:09 pm

    Ed,

    Well, it appears that with the CPP, OAS and age credits, one could easily see around $21,000 from the government at 65. With both spouses collecting that much, that would be enough for many people to retire.

    I don’t know how to calculate the taxes on that since taxtips.ca doesn’t seem to have a place for the age credit (unless I include that in “other income”).

  2. cannon_fodder on November 6, 2008 at 8:44 pm

    Ed,

    Never mind. I see that the age credit is a tax credit, not an actual benefit paid out from the government. THAT is why it is not spoken of too much.

  3. […] Opportunity for non-registered portfolio rich seniors to move their dividend paying stocks into a TFSA to prevent OAS reduction. […]

  4. Barbcgf on January 9, 2009 at 10:52 pm

    I keep reading that the clawback rate on GIS is 50% of taxable income. When I look at the figures in the Service Canada table:

    http://www.hrsdc.gc.ca/en/isp/oas/tabrates/tabmain.shtml

    I see that for an $816 increase in taxable income, the monthly GIS payment is reduced by $17. That would be an annual clawback of $204 which is 25% of the taxable income.

    Am I missing something?

  5. Ed Rempel on January 11, 2009 at 6:10 pm

    Hi Barbcgf,

    I’m not sure what you are looking at, but the clawback is 50%. Are you looking at the GIS for a couple where the difference is reduced from both of them?

    Ed

  6. cannon_fodder on January 11, 2009 at 11:43 pm

    Barbcgf,

    When you look at the annual income tables for combined couples, the table then gives you the monthly GIS for EACH person. Thus, if your combined annual income was $0 to $47.99 the monthly GIS for each person would be $430.90 while if the combined income was $816.00 to $863.99 the monthly GIS would be $413.90 meaning that the couple loses out an extra $17 x 2 (each person) x 12 (months) = $408 or 50% of the increase in income.

  7. Barbcgf on January 15, 2009 at 3:32 pm

    Thanks, cannon_fodder
    My question came at the end of a long day of spreadsheets and tables mapping out our financial future. I knew it had to be something simple like that – it reinforces our decision to be sure we have drawn out all of our RRSP before we become eligible for the GIS

  8. […] working. If this is true, that would be better for RRSP’s. In the introductory article about clawbacks on seniors, however, we saw that this is often not […]

  9. math person on March 7, 2009 at 11:16 pm

    There are two flaws in the marginal tax rates in the table:

    – the income used for the GIS “clawback” does not include OAS. So income ranges should be increased by OAS amt (ie clawback doesn’t start at zero income, but at around 6000, assuming GIS recipient also gets OAS, which they should). Top income for GIS clawback needs to be adjusted by same amount for same reason.

    – age amt is not a credit per se. $10,000 extra income –> 1,500 less age amt –> .15 * 1500 less federal tax credit —> $225 more federal tax. Adding a provincial tax credit of another $75 or so, and total tax went up $300. This is a marginal rate of 3%, not 15%!

  10. […] Rempel has a great article on TFSA and seniors clawbacks for more details on the topic. If you enjoyed this article and would like to be notified when new […]

  11. sundae1888 on May 31, 2009 at 2:53 am

    Is there a comprehensive OAS/GIS (clawback) calculator similar to the tax calculators found on taxtips.ca?

  12. CanadianInvestor on June 11, 2009 at 12:53 pm

    In the table where do the 10% and 8% numbers under Clawback come from? The text says 15% is the clawback rate.

  13. CanadianInvestor on June 11, 2009 at 1:01 pm

    And how does the OAS clawback tax credit work? How do you get a credit for an amount you don’t receive? Did you already pay tax on it somehow? Is it because the OAS clawback happens through reductions in the following year’s OAS payments, which means tax would have been taken off in the current year?

  14. FrugalTrader on June 11, 2009 at 1:12 pm

    Here’s my article on the OAS clawback.

  15. Carl Anderson on January 15, 2011 at 2:34 am

    The comment #60 by “math person” points out a serious error in the tables for marginal rates. The increase in marginal tax rate caused by clawback of the age amount is much less thatn indicated because the reduction in the tax credit is only a small fraction of the 15% reduction in the age amount. It would be helpfull to correct the tables because it leads to very misleading conclusions for people in the 32K to 75K income range.

  16. Showtime on February 15, 2011 at 7:46 am

    Hi, I don’t think I understand some of the key stats in this article and in the tables. Namely, I don’t follow the GIS clawbacks for low income below $15k and the higher tax rate w/ clawbacks on investments like cap gains and dividends.

    According to Gov of Canada tables (http://www.servicecanada.gc.ca/eng/isp/oas/tabrates/tabmain.shtml), someone w/ an annual income of just $400 is going to get a wayyy higher GIS benefit (and combined OAS/GIS benefit) than someone w/ an income of $15k. Where does the 50% clawback come from?

    From what I see about tax rates (http://www.taxtips.ca/marginaltaxrates.htm), lower income people will always pay less tax on cap gains and dividends, etc. How would people w/ less than $15k income pay more tax on investments? I presume that it has to do w/ the above clawback issue that I don’t get.

    Can someone pls clarify these points for me…and explain the data sources and calculations that support the assumption that someone w/ ~$15k income is going to receive higher/better gov benefits than someone w/ very minimal income? Thx.

  17. cannon_fodder on February 15, 2011 at 10:55 am

    Showtime,

    The GIS clawback states that if you had zero taxable income (TFSA income is NOT taxable) you would receive $7,608 (or whatever the max is for that year). If you make $2, the government only gives you $7,607. Thus, whatever form that taxable income is received, you are quickly eroding the benefit of the GIS.

    Now, on the other hand, if you get the GIS it would be typical to think you need it since you have so little taxable income in the first place. The TFSA in a generation or two could change all of that. Some people might build up a very sizeable TFSA and be able to live quite nicely on the TFSA income and the GIS supplement.

    Oh, and just so you know – CPP and OAS are taxable income. So, how do you build up a sizeable TFSA unless you’ve been in Canada awhile? Pretty hard to do that which means you will get some OAS. And, if you are contributing to a TFSA it is also likely you worked at a job where you paid into the CPP.

    I think I remember seeing how small the percentage of government retirement payouts were in the form of GIS payments. It was quite small.

  18. Showtime on February 15, 2011 at 5:58 pm

    Hi,

    Thx for the reply cannon_fodder. I follow the GIS info and it’s basically what I thought. I still don’t see how it supports the author’s rationale. The table shows a blank for gis clawblack over ~$15k (i know the exact cutoff is something more specific), so the chart could be misconsrued as a 0% clawback but it’s in fact a 100% clawback over ~$15k. How can getting nothing (ie no GIS at all) be better than getting something (ie possibly thousands in GIS, regardless of clawback)? I don’t see how the higher tax w/ clawback on investments is calculated either. I presume the clawback is affecting it in someone’s formula but the straight facts say that lower income people are applied a lower tax rate for cap gains, dividends, etc. If the 50% clawback is applied in the modified tax rate, why isn’t the 100% clawback factored in.So the facts tell me that sub-$15k income people get GIS (sometimes much more) and pay less investment tax. I don’t see how the conclusion can be made that that $15k+ people have better benefit and/or tax treatment that sub-$15k people.

    Good points; a lot of those people will have built up OAS eligibility and CPP benefits.

    Anyway, I respect everyone’s research and analysis. I just think it’s important to know which conclusions are irrefutable and which ones are debatable. I believe the author also stated in a diff article that TFSA is better than RSP for 80% of Cdns; I haven’t seen conclusive data that supports that either. That said, the author has many more financial qualifications than me (which is none) so maybe the info just needs to be explained more clearly and I need to understand it better.

  19. Ed Rempel on February 16, 2011 at 12:59 am

    Hi Showtime,

    The GIS clawback applies to income, excluding OAS, up to $15,888. So, for people with maximum OAS (no earnings ever are required), the clawback of 50% applies on all income up to $22,110.

    This is the marginal tax rate, or the tax + clawbacks on the next dollar of income. There is no 100% clawback. Once your income is high enough that you get zero GIS, then there is no longer any clawback.

    The clawback is also on taxable income. So, if the only income you have is $1,000 of investment income, you will pay no income tax, but will lose GIS as follows:

    Interest: Lose $1,000 x 50% = $500 GIS
    Capital gains: Lose $1,000 /2 x 50% = $250 GIS
    Dividends: $1,000 x 1.44 gross-up x 50% = $720 GIS

    My guestimate conclusion that TFSA is probably better for about 80% of Canadians is at: https://milliondollarjourney.com/tfsa-vs-rrsp-best-retirement-vehicle.htm .

    I don’t have stats on how many people are affected by clawbacks or how many people are at similar or higher tax brackets after retiring than before. Therefore my 80% figure is just a guestimate based on people we have seen. We have done financial plans for thousands of families and about 300 tax returns, so we have seen quite a few, but that is not a representative group.

    TFSA would be better for people that spend all or part of their tax refunds, people affected by the larger clawbacks, or people that retire in a similar or higher tax bracket to when they are working. This would include most Canadians, but I don’t know exactly how many.

    Ed

  20. cannon_fodder on February 16, 2011 at 12:04 pm

    Sorry Ed/Showtime. OAS does not count towards testing for GIS. As for TFSA vs RRSP I’d say there’s a consensus that lower income Canadians should consider maxing their TFSA first and then onto the RRSP. It won’t apply in 100% of situations – but the TFSA is a very welcome initiative.

  21. Showtime on February 16, 2011 at 3:33 pm

    Hi Ed,

    Thx for the reply. I think our viewpoints differ on the concept of “free money” from gov programs and how tax is applied. When I said “100% GIS clawback”, that was basically a figure of speech to imply zero GIS. So my point was that people w/ sub-$15k income would be some GIS (ie “free money”, whether clawed back or not) vs people w/ higher income who would get zero GIS. It could be argued that having more income is better overall but I’m just saying none of it would be GIS.

    I think I follow what you’re saying about investment income and gis clawbacks, ie investment income is increasing a person’s overall income so it is reducing GIS. But a higher income person doesn’t get GIS and is in a higher tax bracket, so that’s kind of 2 disadvantages. So I guess the issue is clawbacks on GIS vs no GIS at all, and lower income but more “free money” vs higher income in general but less “free money”.

  22. obscurans on September 2, 2011 at 9:56 am

    I would like to reiterate math person (#60) and Carl Anderson (#66)’s comments that the age amount clawback is grossly overstated in impact.

    Using the current 2010 tax package for actual numbers, the age amount (line 301) is 6446 maximum, reduced by 15% of income over 32506. This clawback will occur over 6446/15%=42973.3 income, so it applies to people between 32506-75749.3 income.

    However, if you look at Schedule 1 (Federal tax), line 301 is in the section Federal non-refundable tax credits, which means it does not reduce your tax bill dollar-for-dollar: it gets multiplied by the 15% nonrefundable rate at line 338. So the marginal clawback rate due to the age amount is 15%x15% or just 2.25%.

    Concrete example, ignoring anything but the basic and age credits:
    Line 260 (taxable income): 40000 | 40001
    Line 300 (basic credit amount): 10382 | 10382
    Line 301 (age amount): 5321.9 | 5321.75
    Line 335 (total amount): 15703.9 | 15703.75
    Line 350 (total tax credits): 2355.585 | 2355.5625
    S1 Line 36 (federal tax): 6000 | 6000.15
    Line 406 (net federal tax): 3644.415 | 3644.5875

    Therefore the marginal federal tax rate at 40000 income is (3644.5875-3644.415)/1=0.1725/1=17.25%, which is exactly the 15% federal tax rate (bracket goes up to 40970 now) + 2.25% age amount clawback.

    This drastically changes the TFSA landscape, as 2.25% is a negligible amount. The net effect is at the mid-income range (well, until the OAS clawback hits), you will be at a lower post-retirement marginal tax rate if you don’t cross into the same tax bracket as you were at pre-retirement.

    The federal brackets as of 2010 are 15% to 40970, 22% to 81941, 26% to 127021, 29% thereafter. Since the OAS clawback probably hits before 81941, as long as you were working at a 26%+ bracket, post-retirement rate is lower right up to the OAS clawback start. If you were working at the 22% bracket, you can go all the way through the 15% to 40970 and your rate will be lower post-retirement.

    PS: for all the people who have a problem equating a benefit clawback with a tax, think of it as not optimizing your ‘tax rate’, but ‘total amount of money in your pocket after all government economic laws are taken into account’. Then your ‘marginal tax rate’ is ‘total difference in money due to government economic laws divided by (a small) difference in income’.

    Looking at it this way, from 40000 to 40001 income (ignore OAS), you go from 36355.585 to 36536.4125 in your pocket after you take into account the government economic laws. You have therefore lost 17.25 cents of your next dollar, to what we lump into ‘tax’. And that is all that matters.

    Then Showtime, once you have lost all the GIS to clawback, on your *next* dollar of income you will not lose any *more* money of your GIS – you’re already completely out. Thus the *marginal* clawback rate from the GIS is zero. And a higher income person who will never care about GIS is at an *advantage* relative to a lower income person whose next dollar is ‘worth’ an extra $0.50 bill due to lost GIS.

    You are of course completely correct in saying that the higher income person is better off on the whole, but 1. that’s not an apples to apples comparison and 2. it’s not what we’re talking about here. We’re taking a look at if we magically drop a dollar of income into someone’s lap, what *proportion* of that dollar can they legally keep, depending on their current total income.

  23. curious on September 11, 2011 at 2:04 am

    Can anyone let me know if there is any way to avoid the gross up on dividends for someone who cannot use the dividend tax credit because they are non taxable? It reduces benefits such as the GIS as noted above.

  24. Ed Rempel on July 18, 2012 at 1:40 pm

    Hi Curious,

    No, there is no way to avoid the dividend gross-up. You are right that it is very punitive for low income seniors that receive the GIS.

    Our advice is that low income seniors that receive GIS should not invest for dividends. They are taxed at 60-70%.

    There are some corporate class mutual funds that invest in dividend stocks but pay out capital gains that are taxed at only 20-30%, or “return of capital” which you can receive for about 10 years before starting to pay capital gains tax on it.

    Ed

  25. Rod on March 12, 2013 at 1:53 pm

    For someone that is over 65…. Retired… And have SM implemented…. House paid off and large portfolio thanks to SM… What are the strategies to pay for the loan interest? RRSP meltdown can help to cover some of the interest, but maybe not all of it. To complement it, I thought about using dividends from the loan investment, but those are taxed at 145% depending on the income level. Any thoughts?

    Once one turns 65, would it be more tax efficient to setup a DRIP and sell the purchased shares every quarter? (to benefit of capital gain tax instead of dividend tax)?

    Trying to find a model to “perpetually” pay the loan interest while maximizing income after 65…. Dividend cash from TFSA would be free, but how about the investment loan?

    Rod

  26. Ed Rempel on March 13, 2013 at 8:57 pm

    Hi Rod,

    That is an excellent question. Interestingly, the Smith Manoeuvre actually works better for low income seniors than anyone else – but it is too aggressive for the vast majority of seniors. Low income seniors are effectively in a 50-70% tax bracket when you include the GIS clawback, so they benefit from the interest deduction more than anyone else, including non-seniors making millions.

    Taking income from the SM takes a lot of planning, though, since there are very low and very high tax brackets – and your tax bracket is mainly determined by how you choose to take income from your SM investments and from RRSPs.

    In your case, Rod, are you in a low or high tax bracket? If you tell me your taxable income before the SM investment income, whether you are married or single, and how much your investment portfolio is, I can give you specific recommendations.

    In general, if you are in a high tax bracket, the lowest taxed types of investment income are return of capital and deferred capital gains. If you are in a low tax bracket, then the lowest tax is return of capital and dividends, followed by deferred capital gains.

    There is an issue with return of capital and deferred capital gains that they can slowly reduce the deductibility of your investment credit line.

    Here are some of the strategies:

    If your income is relatively low (below $23,000 & single), then the interest deduction may qualify you for the GIS. In that case, you want the lowest possible tax on the investments – so you should focus on deferred capital gains and return of capital. This can slowly reduce the deductibility of the investment credit line, but the effect of that is very small compared to the GIS income that you can get. The government in essence pays 50-70% of your interest.

    There is a tiny window if your taxable income including the SM income is between $23-33,000. In that small bracket, dividend income is tax at a -2% in 2012, so you can deduct the interest (only about 20% tax refund), but pay no tax at all on the investment income (or even a small negative tax).

    Once your income is $33,000 or more, then return of capital and deferred capital gains are the lowest tax again, so you probably want to avoid dividends.

    In practice, we usually use corporate class mutual funds and either take a “systematic withdrawal plan” (SWP) or “return of capital” (T8 or T6). They allow you to easily take any amount of income you want, pay it automatically & efficiently to your bank account, and there is almost always little or no tax on the investment income – even when they are growing rapidly and even when you are taking your monthly income from them.

    That does mean we have to calculate the amount of the interest that remains deductible each year, which is a semi-complicated spreadsheet.

    There is a company called Nexgen that has the absolutely perfect tax strategies, but we don’t use them much because none of our All Star Fund Managers are with them. Nexgen is unique, however, since you can get any type of income you want from any type of investment.

    For example:

    – You can get Canadian dividend income from a global equity fund or a bond fund.
    – You can get a monthly payment that is 100% capital gains, so that your entire investment credit line remains tax deductible.
    – You can get 100% return of capital, which means that you can take any amount of income but zero will show up on your tax return (but you have to do the declining interest deductibility calculation).
    – You can take 100% return of capital for 12 years with no tax and then do a tax-free switch to a different fund with exactly the same investments that pays you a 6% Canadian dividend (even though it is a global equity fund).

    Nexgen is amazing, but our advice is almost always that the investment choice must be first. You should almost never take a lower quality investment only for tax reasons.

    That is just an overview of this issue, since it is complex. If you would like a more specific answer for your situation, Rod, then post more details.

    Ed

  27. Rod on March 14, 2013 at 12:39 am

    Hi Ed,

    Thank you for taking the time to answer this.

    I’m 35 years old, married. Income around $100K, wife not working, 1 kid now, planning the 2nd one. Considering my company’s pension and the time for this portfolio to grow, I’ll likely be on the high income when I’m 65. Trying to figure out how much income I’d have in today’s dollar.

    I’ve been leveraging for a while, so I’m comfortable to start with SM. I now have 50% equity on my house and I read every single post of this site and SM thread from redflagdeals. I’m just looking for an “exit plan” before I begin. I’ve already setup a separate IB account for clean trail with CRA.

    House value is $550K, but recently the rules changed to access up to 80% of equity, with the HELOC increased automatically up to 65% of the value of my home. So the maximum I can start with is $165K. Assuming my current mortgage payment and 5% mortgage rate (for history sake), $300 per month goes to the principal to be borrowed and invested. So in 15 years and growing at 7%, I expect at least a $550K portfolio (if rates keep lower, this will be bigger).

    Like yourself, I’d like to never pay off the loan so I can perpetuate the tax deduction on my income. So I’m trying to figure out how to minimize the taxes since dividends (my main strategy to grow the portfolio until I’m 65) will be so heavily taxed after that.

    Meanwhile, I’ve been maximizing TFSA and contributing some to my RRSP and spousal RRSP to lower my current tax bracket. I’m ok to have a large RRSP, since it will grow tax free until we start to withdrawn it, and after that, at least one of us won’t pay any taxes on that by using the RRSP meltdown strategy to cover the loan interest. But I still might need to complement income to cover any remaining loan interest (if rates are high) and our expenses. We have total RRSP of $130K, and expect to contribute $6,600 per year. So in 15 years and growing at 7%, I expect a $525K portfolio.

    I haven’t researched Nexgen yet. I’ll check their options. Since I do the taxes myself, I guess the easiest way is to use the Nexgen fund for 100% capital gains. My loan remains 100% tax deductible and only 50% of the capital gains will be taxed. Sounds like the most efficient way.

    I have 4 main questions:

    1. When I’m 64 and I sell all the stocks prior to buy these capital gain funds… There will be a big hit for that year, having to pay taxes on the capital gains accumulated on these years, right? I wonder if on that year I should take some of the profit and put in the RRSP to offset the taxes?

    I have an impression that the more I have on RRSP, the better, as I can almost always guarantee to cover the interest (even if they’re high) and not incur income tax with RRSP meltdown? If I convert to RRIF and only withdrawn the minimum, it should cover the interest and generate very little if any income?

    2. To perpetuate even further for my next generations… In Ontario, we can designate a beneficiary for TFSA… can I designate my child even if he’s under 18? If I can’t, what happens to the funds case me and my beneficiary (wife, then) passes away?

    3. What are the tax implications for the SM loan / house to my kids if both my wife and I pass away… Any tax strategy that can be used with a will?

    4. There’s currently $25K on each TFSA, so if I continue contributing $5,000 per year and assume 7% growth, that’s another $195K on each, where dividends can provide at least $10K withdrawn per year easily on each TFSA. TFSA can be withdrawn with no taxes or clawbacks implications, correct? Did the government pass the law for withhold dividend tax on US dividend stocks?

    Thanks so much for taking the time to share such valuable information!

  28. Ed Rempel on March 16, 2013 at 1:27 am

    Hi Rod,

    Wow, I’m impressed by your long term planning! You covered a lot, but here are my comments:

    1. You can start your SM at 80% of your home value. At most banks, the new OSFI rules are an issue when your mortgage is less than 15% of your home value, not when it is between 65-80% of home value.

    2. RRSPs can get too large if they put you into the high tax brackets with clawbacks after you retire. In your case, that is very unlikely, since your wife is not earning and you can contribute mostly or only to her spousal RRSP, and because you have a pension you get less RRSP room.

    3. In the TFSA vs. RRSP debate, in your case, your available investment money each year is probably best used first to maximize your RRSP (since you are in a 40+% tax bracket and will almost definitely be in a lower bracket after you retire – or at least contribute enough to bring your taxable income down to about $81,000.

    4. In the TFSA vs. Smith Manoeuvre debate, in most cases it is more beneficial to use your extra cash to pay down your mortgage more quickly and reborrow to invest than to invest that amount in your TFSA. The TFSA gives you tax-free growth and dividends, but if you invest tax-efficiently, you can usually get tax refunds almost every year from the Smith Manoeuvre. Tax refunds beat tax free. Your dividend strategy would create a bit of tax drag on the SM, since it is less tax-efficient than deferred capital gains, but it sounds like your investments would be tax-efficient enough for the SM to beat TFSA (assuming very little trading to trigger capital gains).

    5. Selling all your dividend stocks at age 64 to avoid the high clawback tax on dividends starting at age 65 might make sense. Without doing a retirement plan and figuring out what your taxable income would be after you retire, you may or may not be in a clawback zone. Remember that the income from your Smith Manoeuvre investments can be favourably taxed as capital gains (or deferred capital gains or return of capital) while you can deduct all of the interest each year.

    6. If it does make sense to sell all your dividend stocks at age 64, you may want to plan around that, such as spreading it over several years to avoid putting yourself in too high a tax bracket, or perhaps changing your investment strategy years earlier. Your idea of saving RRSP room so you can contribute to offset it sounds like a good idea, but you will probably benefit more from contributing to your RRSP earlier.

    7. Successor holders (beneficiaries) for your TFSA must be over 18. However, I believe you can have the TFSA held in trust until your kids reach 18. Are you planning to be over 65 and have kids under 18? :) Good for you, Rod!

    8. If your kids continue the Smith Manoeuvre, it would be tax deductible to them as well. They can keep the investment credit line and the investments. In most cases, though, your kids probably will not want to keep your home and may sell it. If they want to keep the SM going, they would have to refinance the investment credit line to maintain the tax deductible debt. They could do this either by paying it off with a credit line against their own home or by taking out an investment loan to pay it off. They can decide all this after you are gone. Nothing is necessary in your will. All you can do is educate your kids in the strategy and then trust them to make the decision that is right for them at the time.

    9. The reason there is tax withholding on U.S. dividends in your TFSA is that this is not provided in the Canada-U.S. Tax Treaty yet. It is provided for RRSPs, so there should be no withholding in your RRSP, but there is in TFSAs. My guess (and it is a guess) is that governments are slow to negotiate and that in 5 or 10 years they will include TFSAs in future versions of the Tax Treaty to avoid tax withholding.

    10. Your dividend investment strategy is a good strategy. It is the currently popular strategy, so you may want to consider whether or not you want to commit to it until age 64. In the last 20 years, the most popular investment strategy has gone from emerging markets to technology to bonds to income trusts to resources to bonds and finally to dividends. The popular strategy changes regularly. Today it is “anything with a yield”. My guess is that in a few years, something else will be most popular. The most likely scenario is probably a very strong market for the next few years (after the last decade being the worst in 80 years), which would lead dividend stocks to lag for quite a few years. That is just one scenario, but I raise it to illustrate that likely some other strategy, such as growth investing, will be more popular in a few years. The strategy to avoid is to chase the currently popular strategy. Therefore, you should either diversify your strategy now or commit to sticking with dividends even if they lag for many years.

    Just some thoughts to plan ahead. I hope this is helpful, Rod.

    Ed

  29. Rod on March 16, 2013 at 11:54 pm

    Thanks Ed, this was very helpful. I’ll use your mortgage referral service to get the readvanceable mortgage. I’ll take a closer look on the thoughts provided above. I do use some growth strategies for speculative capital by doing pre-earning plays every quarter using Options. But that’s trading, for short term. I think the dividends provides a good long term investing strategy.

    Thanks again!

    Rod

  30. Rod on March 18, 2013 at 8:57 am

    Hi Ed,

    You mentioned that deferred capital gains is more efficient tax-wise than simply paying dividend taxes every year.

    Is it possible to implement such strategy with regular dividend paying stocks? How would one choose to defer it? The idea is certainly to hold those stocks for many years, to make it effective.

    As a DIY person, I’m trying to assess how feasible is this option compared to a mutual fund that offers deferred capital gain tax type of class.

    Thank you,

    Rod

  31. gogernator on April 14, 2014 at 5:39 pm

    RRSP vs TFSA. I have a quick question, my mom is/has retired for all intensive purposes, but wont’ be converting her RRSP for another 8yrs or so. Her current gross annual income is about 20K. Would it make sense to take some of her RRSP money and completely fund her TFSA? If she takes 31K and invests and gets a return of 9% (which would be good going) her investment would have a little less than doubled in 7 years. That 31K would now be worth 56K or so, and be completely tax free. If she has also been investing in securities with a dividend yield in the 3.5% range she will now be able to harvest about 2K per year completely tax free. If on the other hand she leaves it in her RRSP and invests in the same products, at some point she will pay some tax on the accumulated monies.

    As a side note, my moms RRSP is not substantial.

    Your thoughts would be much appreciated.

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