Yesterday I met with a couple, Josh and Leah, who I’ve worked with just over a year. I really look forward to our meetings…especially when their beagle comes streaking over when I visit…..such a friendly boy!
It has been a busy first year getting their planning organized. But now with most of their planning completed, they asked a question I hear often.
Josh stirred his coffee. “Adrian, we feel so much better that our investments are streamlined. Now, should we contribute to our TFSAs?”
In a world where doctors pay an incredible amount of taxes with so few ways to avoid paying them, a TFSA seems like a no-brainer. And it is!
(Sort of…)
“I know it feels like it’s a missed opportunity, not having regular contributions to your TFSA,” I replied. “You’d be able to see it grow tax-free and not have that constant irritation of paying tax in the future.”
“That’s it exactly!” said Josh. “Everywhere we turn there’s another tax bill to pay. It would just be nice to have something we knew the government couldn’t touch or increase on us later. We already pay so much tax it’s ridiculous.”
“I have another word for it.” Leah added with raised eyebrows. I was pretty sure I knew what she meant!
“I actually really like TFSAs.” I continued. “But ONLY when there’s a tax-free or tax-preferred way to get the money out of your Prof Corp first. Otherwise, you’re choosing to pay up to $800 more in tax just to put $1,000 into your TFSA.”
“That’s almost the same tax as what we’d be saving!” Leah replied. Their faces clearly showed their frustration. It felt like a Catch-22. They couldn’t take advantage of the Tax Free Savings Account because of the tax they’d have to pay FIRST on the cash destined for the TFSA.
“You said you like TFSAs when there’s a tax-free or tax-preferred way to fund them from your Prof Corp . How can we do that?” Leah asked.
“Well, while your investments from your previous advisor have gone up over time, they haven’t kept up with most portfolios. We’ve talked about that.”
They both nodded as I continued.
“We never want the tax-tail to wag the dog – improving your portfolio’s performance is always the higher priority. But it also gives you an opportunity that the tax man isn’t going to like – but can’t stop you from doing.”
They immediately grinned and moved forward on their couch. I did the same thing – I love doing this kind of planning!
“Okay, if we take money out of your corporation to invest in TFSAs – we’ll use this strategy FIRST.
Yes, there’ll be some corporate tax to pay, but there’s also going to be some tax-free capital gains, which could be paid to you, also tax-free.” I advised them.
“We could put the money into our TFSAs!” they both shouted.
“Well, yes. But into your RSPs first.” I added.
Now they looked a bit confused.
“I thought we’re trying to put money into our TFSAs?” Josh asked me.
And this is where it gets fun!
RSP refunds are a great strategy to fund your TFSA
“You’ll contribute to your TFSA with the refund you’ll receive from your RSP contribution.
Because you’re in a high tax bracket, you’ll get back almost half of the amount you contribute to the RSP AND you’ll use that refund to make your TFSA contribution. And it all grows either tax-deferred or tax-free until you need the funds in retirement.”
The coffee was going cold on the table, left untouched as we spoke. Leah and Josh have always been quick to understand strategies, and this felt like they’d make the tax rules work for them, not the other way around!
“For example, if we changed some of your investments, and we had a $100,000 capital gain, currently $33,000 would be tax-free and we could elect to pay that out as a tax-free capital dividend.”
(At the time of this newsletter, the inclusion rate is 2/3rds of a gain…fingers crossed it goes back to 50% in which case this example would be $50,000 out tax-free!)
“We contribute the $33,000 into your RSP. At your tax rate, you’d expect about $15,500 as a tax refund which we then contribute into your TFSA.”
Leah caught on immediately.
“Let me repeat this back to you so I know I’ve got it right. We move some of our investment money around to improve our returns, take out what we can that’s considered a tax-free capital dividend and then $33,000 becomes almost $50,000 and the government can’t tax it?”
I nodded.
“You’re partially correct. You do have to pay the tax piper for the RSP but not until retirement. You’ll likely have a lower tax bracket as your kids will be grown, your mortgage a memory, and we can balance your income. The cherry on top is after age 65, your RSPs we can convert to a RIF so you each get a $2,000 per year pension tax credit, further reducing your tax burden.”
Josh and Leah looked at each and did a quick high-five. “Our investments improve, we have more saved, and the CRA loses. I love it!” said Josh.
We got up and poured out the cold, old coffee and started with fresh hot cups. Leah had her calculator and Josh was writing like mad. Excitement was in the air. And we got down to making 2025 a very good year.
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