You know you are a financial keener if you set up a new TFSA and after 2 months, are thinking about transferring to a different financial institution. Reader Kim commented on a recent TFSA post that he is thinking of doing exactly that.
Here is his comment:
Great information…and I have $5000 in an ING TFSA.
I was wondering if there are consequences of taking some of the money out of my ING TFSA and opening another TFSA at a different institution that allows Stock purchases in the account rather than just cash? As I understand it, any increase in the value of the stock is tax free which COULD be quite substantial.
This brings up a number of very interesting issues and a couple of possible strategies for transferring TFSA money from one institution to another.
First of all he mentions having $5,000 in his TFSA – since that the annual contribution limit and the TFSA program is in its first year – obviously he doesn’t have any contribution room left for 2009.
TFSA transfer to new financial institution
TFSAs are similar to any other kind of account such as an RRSP – you can do a transfer to a new institution without having to withdraw from the TFSA. You can either transfer-in-kind which means that any investments in the TFSA get moved over to the new institution – for example if you own shares in the TFSA, they will be moved without having to be sold and then bought again. Transfer-in-cash means that the investments are sold and only the cash amount is moved to the new institution.
In this case the transfer will be in cash.  As a result of this transfer there will be no withdrawal or contribution to the TFSA. One thing to be aware of is the transfer fee. Most institutions charge this fee which is generally $100 to $150. If you are transferring to a discount brokerage and have sufficient assets then you might be able to get them to cover this transfer fee. Given that the TFSA only has $5,000 of contribution room, it is unlikely that anyone has enough in their TFSA to get a free transfer (unless of course they have made some incredible trades). Of course you should check if your institution charges this fee and how much it is.
TFSA withdrawal and contribution strategy – aka “The December Strategy”
Another strategy to think about if you are looking at a steep transfer fee is to just withdraw the TFSA money from the existing account and then contribute it to the new TFSA account. The TFSA rules state that any withdrawal will result in an increase of the available contribution room by the same amount in the following calendar year. Assuming that withdrawals are not charged fees (or less fees than the transfer) then someone could do this strategy with the only problem being that they can’t recontribute the money in the same calendar year unless they have enough unused TFSA room which is not the situation in Kim’s case. This is a valid strategy in December (preferably the end of December) because then you can take the money out, wait a couple of weeks and then recontribute it at the new company.
In a few years, most Canadians will probably end up with a lot of unused TFSA contribution room. Let’s face it – between mortgages and the RRSP – there is only so much benefit for the TFSA.  For those people, there won’t be an issue if they want to move their TFSA – they will be able to just withdraw and recontribute in the same year by using their unused contribution room.
Keep in mind that contributions and withdrawals might end up needing a line or two in your tax return.
What kind of investments are suitable for the TFSA?
And finally on to the point that I think Kim was actually asking about – should he invest in stocks vs high-interest savings account in a TFSA account for tax reasons?
First of all – the tax considerations should not be the driver of your asset allocation. The first step should be determining what type of investment (cash, stocks, bonds) you want this money to be in. The next step is to figure out what type of account (TFSA, open, RRSP) it should be in.
As far as the potential tax savings – it’s hard to estimate without being able to predict the future but here are a couple things to think about:
- You can’t claim a loss inside a TFSA. (Not that stocks can get any lower or anything)
- 3% interest on $5k at 40% marginal rate will save $60 of income tax per year. To have an equivalent capital gains tax benefit you would need a 6% return. Because capital gains tax applies to half of the profit – the rate of return has to be twice the interest rate to break even. 6% stock appreciation is not unreasonable over the long term but will interest rates stay at 3%?
- Transaction fees for the stocks. I didn’t include these in my break-even analysis but they would be a factor. Kim mentioned buying stocks with “some” of the TFSA money – less than $5k is not a lot of money to buy individual stocks with so maybe an index mutual fund would be better. He should look into TD e-funds for that.
If you are looking for more information on mutual funds, index funds and ETFs then sign up for a Morningstar free account. Morningstar is the industry leader in investment information.
{ 4 trackbacks }
{ 12 comments… read them below or add one }
Thanks for the link and the informative post.
Great post 4P – bookmarked!
Great post.
I’m probably in the same mindset as Kim and I am still struggling with the points you raise in the final section, not just because I can’t predict the future, but also because I don’t have all the pieces of the puzzle.
Once you determined the types of investments you want to hold based on your time line and risk level, you need to determine in what types of accounts to hold them, in part based on their relative tax efficiency, but also based on their ability to have compounding/tax-deferred growth. Your math looks at just a single year. Would the model change over time?
The TFSA is capped to $5k (indexed) per year, but by putting faster growing investment vehicles in the TFSA, I can push the value held in the TFSA up beyond ( $5k * x years ). Lets look at just my initial $5k TFSA contribution this year and disregard the $5k I will be contributing in future years. In a savings account, at 4%, it would grow to $16k in 30 years, whereas at 6% returns on stock it would grow to $28k. For someone who hopes to max out his TFSA each year, that difference in the space inside the TFSA could result in a substantial difference in the tax bill years from now, when the difference will be a whole lot more than $60.
Assuming the same 40% marginal tax bracket and retirement decades away, certain types of investments seem to be better held in one type of account than another. Ideally I’m looking for someone who has tabulated the pro’s and con’s of placing a particular type of investment in the various accounts over a longer period. What should I consider when holding foreign dividends in a TFSA, RRSP, vs a non-registered account? How about Canadian dividends, REITs, GICs, etc.
I started building a table like this on my own which has more gaps than text. For example for Canadian dividends I wrote: “Dividends are very tax efficient. There are much better funds to put into a tax-sheltered account.” (i.e. I maxed out my RRSP and TFSA this year and when opening a non-registered account these might be among the investment types to consider shifting there.)
I my comment is all a very general. To bring it back to Kim’s question: what would be good reasons to hold equity in a TFSA?
I recently opened a TFSA at Questrade. I’m figuring on filling it with income trusts and have their monthly distribution placed into the account. Figuring some are paying 10 to 20% right now, it will be all tax free to take out come December.
Steve – that’s a great plan. I hadn’t thought of using the TFSA that way.
J: That is a good strategy. I personally am planning on using the TFSA as an income producing vehicle, so I’ll be placing investment grade corporate bonds, income trusts and non-Canadian dividend paying stocks.
The plan is to build a passive income vehicle right now it may not be big but over longer time period it will save me a lot on taxes.
I’d rather place Canadian dividend paying stocks in non-registered and take advantage of the tax credit.
I discussed some TFSA strategies in one of my recent posts.
On the thought of foreign dividend paying stocks, check to ensure the country in question recognizes the TFSA, as of today, the US does not, which means any gains on US securities will be subject to witholding tax, whereas RRSP is recognized.
My understanding is that you can have more than one TFSA.
So, why not just open a second account for buying stocks and avoid any fees associated with collapsing the original TSFA.
I. Pedlar – yes, that is always an option but Kim wanted to use the money in his existing TFSA.
Don’t know if I’ve done the right thing… I wanted to try this strategy: I’ve invested into 4K in ETF Gold and 1K in ETF Double Oil (that HOU!). For the moment, the performance is significantly negative. Not sure what to do next…
Since $5k is not a lot of money (in the investment and retirement world) my strategy would be to invest in a very high risk mutual fund. If I can compound 10 -15% returns over several years, I will accumulate significant funds to withdraw in 25 years, all tax free. Otherwise, I might just as well invest the $5k in my RRSP and reduce my income tax rather than save tax on ($5,000 @ 2.5% earns $125 @40% tax equals about $50 tax). If my risky investment loses 20% in one year (I have lost $1,000) and my TFSA has a face value of $4,000 left in it. If, on the other hand, my risky investment earns 20% my TFSA value becomes $6,000 to which I will add another $5,000 in 2010 and earn return (or losses) on $11,000. I think it’s wise to use this strategy for long term planning as opposed to considering removing the funds from the account in short periods of time. Used wisely, this strategy over 25 years compounded with a 10% interest not indexed will return approximately $545,908 tax free. Using a more conservative return of 6% (not unrealistic) the account would be worth $295,781. As you can see, earning a higher return has significant consequences. Going back to my initial comment, 5k is not a lot of money so if you can afford to gamble with the money, take a chance and if you can’t, then don’t. The strategy for TFSA is specific for each individual and you need to be comfortable in the shoes you wear.
Good advice to use the money in a Mutual fund. I invested mine in a high yield mutual fund, this way I get a lot of dividends (set them to re-invest) and make money if the stocks go up. I chose the TD high yield income