Benefits derived from asset purchase and sale transactions (“swap transactions”) between RRSPs and other accounts controlled by the RRSP annuitant. A swap transaction is a transfer of property (other than a transfer that is a contribution or a withdrawal) between an RRSP and the RRSP annuitant or a non-arm’s length person. Subject to the application of existing anti-avoidance rules, these transfers, when performed on a frequent basis with a view to exploiting small changes in asset value, can potentially be used to shift value to or from an RRSP without paying tax or using RRSP contribution room, as the case may be. An exception will be provided to accommodate transfers from one RRSP of a taxpayer to another RRSP of the taxpayer.

The Budget proposals are aimed at eliminating “advantages” of a swap transaction which are defined as benefits that intend to exploit the tax attributes of a RRSP. However, media reports indicate that some financial institutions are now prohibiting all swaps with RRSP accounts, not just those that run afoul of the new advantage rules.

One hopes that brokers don’t end up issuing a blanket ban on swaps in RRSPs as many did when similar rules were introduced for Tax-Free Savings Accounts (TFSAs). One can skirt a blanket ban on swaps by buying and selling assets separately in two TFSA/RRSP/taxable accounts. But if one or both assets are not liquid (a GIC, for example), a swap may be the only way to exchange assets between a tax-deferred account (an ideal place to hold GICs) and an investment account. At least with TFSAs, one could work around a ban on swaps by withdrawing funds from the account and contributing in-kind during the next financial year. With RRSPs, brokers will be throwing out the baby with the bathwater if they impose a blanket ban on RRSP swaps.

Related:
The Blunt Bean Counter weighs in on the new advantage rules regarding swap transactions.

Tax expert Jamie Golombek says the new rules target misuse of RRSPs.

Related Reading:

• Why ban swap transactions in TFSA accounts?
• TD Waterhouse Disallows RRSP Swap Transactions
• RBC Dominion’s Reasonable Stance on RRSP Swaps
• FAQs on Tax-Free Savings Accounts
• TFSA Excess Contribution Penalties Ensnare Taxpayers

A Blanket Ban on RRSP Swaps is a Bad Idea is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

Defer income taxes

RRSPs allow taxpayers to defer their income tax obligations to a future year. Taxpayers with wildly fluctuating incomes can smooth out their income tax obligations by contributing to a RRSP in fat years and withdrawing from it in lean years.

Income splitting

When one spouse earns a much higher income than her partner, she can take advantage of income splitting opportunities offered by RRSP accounts. She can contribute to a spousal RRSP and get her income taxed at the hands of the lower income spouse. She can take advantage of income splitting available to seniors who withdraw from a RRSP or RRIF. The tax benefits of income splitting can be substantial.

Increase in income-tested benefits

It is true that withdrawals from a RRSP or RRIF may result in a reduction of income-tested benefits. But the flip side is often neglected. Contributions to a RRSP reduce one’s taxable income and increases income-tested benefits such as the Canada Child Tax Benefit.

Here’s an example. An Ontario couple with two children, earning $50,000 each will receive an annual CCTB of $335. If the couple contribute $9,000 each to their RRSPs their CCTB payments will increase to $1,055 per year.

Shelter foreign investments from tax

Investors who hold globally diversified portfolios should hold their US equities and US-listed ETFs in their RRSPs. Dividends from foreign equities in taxable accounts are taxed at marginal rates. US stocks and ETFs held in TFSAs are dinged a 15% withholding tax. When held in RRSP accounts, these assets are sheltered from tax until withdrawal.

Bottom line

Canadians in the lowest tax brackets will almost certainly better off saving for retirement inside a TFSA. And those in the highest tax brackets are almost certainly better off contributing to RRSPs at the expense of TFSAs. It is impossible to say with any degree of certainly whether one account is better than the other for Canadians in middle tax brackets because of uncertaintly over future tax rates. The superiority of TFSAs is certainly not the slam dunk it is made out to be in some quarters.

Related Reading:

• C. D. Howe’s take on TFSA versus RRSP
• Tax-Free Savings Account (TFSA)
• Ideas for your Tax-Free Savings Account (TFSA)
• A Blanket Ban on RRSP Swaps is a Bad Idea
• Dividend Stocks in a RRSP

The Advantages of RRSPs over TFSAs is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

Let’s look at a concrete example of a TFSA December Strategy. Say you have a TFSA at Bank A invested in a high interest savings account. You are interested in moving the TFSA from Bank A to Bank B for whatever reason. Some institutions may charge as much as $125 to $150 to transfer your account. But TFSA accounts typically allow a certain number of free withdrawals. Even if the institution charged a withdrawal fee, it is likely to be much less than a transfer-out fee.

Here’s what you could do: withdraw the entire balance from your TFSA account in Bank A towards the end of December. When the New Year rolls around, open a new TFSA account at Bank B and deposit the amount you withdrew from Bank A. The December Shuffle works best for TFSA accounts that hold cash or cash equivalents. But it can also work when you hold investments in a TFSA and want to move it to another institution. For instance, if you and your spouse each have a TFSA account and it holds one security, you could withdraw the contents of both to an investment account and transfer it out to another broker allowing you to avoid at least one transfer out fee. As always, watch out for fees, tax implications and do own your due diligence because fee structures at your institution may be different.

There are a few situations in which the December Shuffle doesn’t make sense:

1. Some financial institutions such as ING Direct and Ally do not charge transfer fees. If you moving your TFSA from an institution that allows free transfers, you may not want to bother with the December shuffle at all.

2. If you have large accounts at the target institution, you should ask for a refund of TFSA transfer fees. Many institutions may initially balk at a transfer fee refund for a small account but these fees are always negotiable. If you can swing a transfer fee refund, the December shuffle becomes moot. Just fill up and sign the TFSA transfer form and you are done!

Related Reading:

• 2010 Year-end Financial Deadlines
• FAQs on Tax-Free Savings Accounts
• 2009 Year-end financial deadlines
• Reader question on transferring a RRSP account
• TFSA Excess Contribution Penalties Ensnare Taxpayers

The TFSA December Transfer Strategy is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

The Government is indicating that taxpayers whose net TFSA contributions never exceeded $5,000 can expect a penalty waiver. The excess TFSA amount penalties incurred by taxpayers who used their TFSA as a savings account and made frequent deposits and withdrawals and / or transferred their TFSA account from one bank to another by withdrawing from one and contributing to the other will be considered to be a result of reasonable error. It is not clear if taxpayers whose net TFSA contributions exceeded $5,000 are also deemed to have been genuinely confused about TFSA rules.

One wishes the financial institutions which were so eager to sign up as many TFSA accounts as possible had been a little more proactive in catching TFSA excess amount errors and warning clients that they might be running afoul of TFSA contribution rules. I wonder how many banks still have no warnings of any sort when a client tries to make a contribution to a TFSA account. When I opened an account with Ally Bank early this year, they refused to accept an initial contribution over $5,000. However, when I tried to contribute another $1.00 to my TFSA account, there were no warnings or cautions of any sort. Is it any wonder that so many Canadians have inadvertently “over contributed” to their TFSA accounts?

You can find the press release here.

Related Reading:

• TFSA Excess Contribution Penalties Ensnare Taxpayers
• Apply for waiver of TFSA over-contribution penalties
• FAQs on Tax-Free Savings Accounts
• This and That
• The TFSA December Transfer Strategy

Government Waives Some TFSA Penalties is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

Update on June 27, 2010: The Government has decided to provide relief to taxpayers whose net TFSA contributions never exceeded $5,000 in 2009. The deadline for responding to the TFSA return letter from the CRA is August 3, 2010. You are asked to respond to the CRA letter by providing additional information or explanations that you may have in respect of your over-contributions. Details here.

If you are one of the reportedly more than 70,000 or so tax payers who has been penalized by the CRA for excess TFSA contributions and the error arose as a consequence of a reasonable error and are looking for relief, I urge you to read Rob Carrick’s column in the Globe and Mail today (See Confusion over TFSA rules leads to costly penalties for some investors):

Accidentally contributed more than $5,000 to a TFSA? It may still be possible to avoid penalties for over-contributions. Paul Hickey, partner at KPMG’s national tax centre, suggested using CRA’s tax fairness provisions by submitting a Request For Taxpayer Relief form.

“Interestingly the TFSA provisions contain a special rule which allows the CRA to waive or cancel all or part of the penalty if you can establish “to the satisfaction of the Minister that the liability arose as a consequence of a reasonable error,” and that the individual acts without delay to fix the problem,” Mr. Hickey said in an e-mail.

Here are the specific provisions in the TFSA legislation that would allow taxpayers to request a waiver of tax payable:

Tax payable on excess TFSA amount

207.02

If, at any time in a calendar month, an individual has an excess TFSA amount, the individual shall, in respect of that month, pay a tax under this Part equal to 1% of the highest such amount in that month.

Waiver of tax payable

207.06

(1) If an individual would otherwise be liable to pay a tax under this Part because of section 207.02 or 207.03, the Minister may waive or cancel all or part of the liability if

(a) the individual establishes to the satisfaction of the Minister that the liability arose as a consequence of a reasonable error; and

(b) the individual acts without delay to cause one or more distributions to be made, under one or more TFSAs, the total amount of which is not less than the amount in respect of which the individual would otherwise be liable to pay the tax.

Also see Money Smarts Blog’s post on this topic.

How to apply

I should note here that I’m not a tax professional or accountant but here’s how I’d apply for a excess TFSA amount penalty waiver.

1. Fill out the form Schedule A, Excess TFSA Amounts (Form RC243-Sch-A) and attach a cheque for the TFSA penalty amount. Mail it in to the nearest tax centre before June 30, 2010.
2. File a Request for Taxpayer Relief (Form RC 4288). Ask for a waiver under 207.06 of the Income Tax Act. Show how the penalty arose as a result of a “reasonable error” AND the steps you have taken to rectify it (by removing the excess amounts). Mail it in to your nearest tax centre.

Rob Carrick writes in the Globe and Mail that the CRA may provide relief on a case-by-case basis.

James Daw in The Star (Don’t panic! Appeal penalty tax on tax-free savings) has a step-by-step process to apply for a waiver of TFSA excess amount penalties.

Related Reading:

• Government Waives Some TFSA Penalties
• TFSA Excess Contribution Penalties Ensnare Taxpayers
• This and That: TFSA penalty waivers and more…
• Should U.S. Estate Taxes Affect the Choice of Investments?
• Surplus Allocation Act

Apply for waiver of TFSA over-contribution penalties is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

In some cases, the penalty could be hefty. For instance, let’s say a taxpayer opens a TFSA account at Bank A in early January and makes an initial contribution of $5,000. Later in the month, he hears that Bank B is offering a much higher interest rate for TFSA accounts. He withdraws the entire balance from the TFSA account at Bank A, opens a new account at Bank B and deposits the $5,000. Now, according to the TFSA rules, he has an excess TFSA amount of $5,000 for January. If the taxpayer maintains the account balance at Bank B until the end of the year, he has an excess TFSA amount of $5,000 for each month of 2009. The penalty: $5,000 * 12 * 1% = $600. In a typical TFSA savings account, our taxpayer would have earned about $100 to $150.

Many taxpayers are understandably mad to find that they have been tripped by TFSA rules. They are taking to the Internet to make their displeasure clear with the Government. There are petitions floating around asking the Government of Canada waive all TFSA over contribution penalties resulting from “unintentional errors” and “general misunderstanding” of the workings of the TFSA. It is hard not to feel some sympathy for the plight of taxpayers who inadvertently made excess contributions to the TFSA but a blanket waiver would be unwise.

First, it should be pointed out that TFSA rules were clear even before financial institutions started offering these accounts (See post FAQ on Tax-Free Savings Accounts dated December 1, 2008). It is hard to make the case that CRA rules were somehow unclear as some are trying to. Second, clients have a legitimate complaint if their financial institution or financial advisor made no effort to caution them not to exceed the TFSA contribution limit in cases where contributions and withdrawals were made to the same account. (It should be pointed out here that ING Direct posts a notice that says “Please double check your TFSA contribution limit to avoid exceeding it. This means adding up all the contributions you’ve made to TFSA accounts at ING DIRECT and your other Financial Institutions”.) But, this is a matter that should be taken up with the institution or advisor, not the Government. Finally, taxpayer relief provisions already allow the CRA to forgive interest when the taxpayer is experiencing financial hardship. For all these reasons, waivers should only be considered on a case-by-case basis.

Related Reading:

• Government Waives Some TFSA Penalties
• The TFSA December Transfer Strategy
• FAQs on Tax-Free Savings Accounts
• Apply for waiver of TFSA over-contribution penalties
• Ally: A Good Choice For Savings Accounts

TFSA Excess Contribution Penalties Ensnare Taxpayers is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

The marginal effective tax rate (METR) is the tax rate bearing on an incremental dollar of income, or the next dollar earned. For individuals, comprehensive METR measures take into account the income thresholds and statutory rates of the personal income tax system, as well as the impacts of tax deductions and credits and income-tested federal and provincial benefits.

The authors then compute the difference in METRs between working-life income versus retirement income and produce graphs such as the one shown below (the graph shows the METR delta for a Single, Ontario resident replacing 60% of working life income) for three provinces (Alberta, Ontario and Quebec) and three income replacement rates (80%, 70% and 60%).

The graph confirms our suspicions that lower income Canadians are better off to save for retirement in a TFSA. Recall that withdrawals from a RRSP result in a claw back of the Guaranteed Income Supplement (GIS) boosting the effective tax rate to as much as 70%. On the other hand, withdrawals from the TFSA are not counted in calculations for income-tested benefits handing the TFSA a massive advantage for low-income Canadians.

However, there is a surprise in the findings. The report’s METR comparisons seems to suggest that Canadians in middle tax brackets (such as those Ontario residents earning between $54,000 and $81,000 and aiming for a 60% replacement rate) might be better off saving for retirement in a TFSA.

Unfortunately, I think the analysis, which seems complicated enough, is still too simplistic. What matters in comparing the TFSA and RRSP is not the METR, it is the AETR (average effective tax rate) on contributions to a retirement account and the AETR at the time of withdrawal. Let’s take a simple example. A one-income household with an annual income of $100,000 will likely have a AETR of 43% in their working years. For a 80% replacement rate, the AETR on withdrawals is likely to be 30% or less because (a) due to income from the CPP, most of the GIS is clawed back anyway, whether or not the household receives another dollar of income from a RRIF and (b) income-splitting opportunities that allow the household avoid the OAS claw back. Add children to the mixture and the analysis becomes even more complicated because RRSP contributions will not only result in tax deductions but also increase CCTB payments.

Ultimately, the TFSA versus RRSP question is largely academic because who knows how tax rules, brackets and rates will evolve and change in the future. For now, it seems clear that low-income households can skip the RRSP and save in a TFSA. Everyone else can probably safely cover all bases by contributing as much as they can to both the TFSA and RRSP. If they save predominantly in one vehicle rather the other, they are still likely to come out ahead because what matters most is that they saved for their retirement, not which savings vehicle turned out to be marginally better in retrospect.

You may also be interested in what The Wealthy Boomer and Canadian Financial DIY have to say on the topic.

Related Reading:

• Ideas for your Tax-Free Savings Account (TFSA)
• Tax-Free Savings Account (TFSA)
• PH&N’s take on the investments in a RRSP or outside debate
• Dividend Stocks in a RRSP
• RRSP versus TFSA versus Mortgage Paydown

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“Asset transfer transactions” (sometimes known as “swap transactions”), in this context, refer to transfers of property (other than cash) for cash or other property between accounts (for example, a Registered Retirement Savings Plan (RRSP) and another registered account) that are generally not treated as a withdrawal and re-contribution, but instead as a straightforward purchase and sale. Subject to the application of existing anti-avoidance rules in the Income Tax Act, these transfers, when performed on a frequent basis with a view to exploiting small changes in asset value, could potentially be used to shift value from, for example, an RRSP to a TFSA without paying tax, in the absence of any real intention to dispose of the asset.

Michael James wrote a pretty good explanation on how frequent swaps between a RRSP and a TFSA can slowly transfer assets from the former to the latter, which can then be withdrawn tax-free. But banning swaps entirely doesn’t really solve the problem. Though it is more expensive, selling an asset in one account and buying it in another achieves the same result that a swap does and is still open for someone wanting to shift value from a RRSP to a TFSA. So, why ban swap transactions altogether? Informed speculation is welcome.

Related Reading:

• A Blanket Ban on RRSP Swaps is a Bad Idea
• TD Waterhouse Disallows RRSP Swap Transactions
• The TFSA December Transfer Strategy
• FAQs on Tax-Free Savings Accounts
• RBC Dominion’s Reasonable Stance on RRSP Swaps

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Ideally, I would like to open an account with my main bank (Royal Bank) but RBC’s TFSA is relatively unappetizing – while there are no administration fees or withdrawal fees and the savings account pays a relatively solid 0.75%, the redeemable GICs pay a paltry 0.05% for a 1-year term with an early redemption rate of 0.03%. I don’t know why RBC even bothers selling these GICs: on a $5,000 investment, RBC’s redeemable GIC would pay an interest of $2.50 if it is held for the entire term – just enough to buy two sticks of chewing gum.

Other banks are hardly any better. TD Bank and Scotia offer a slightly higher rate of 1% on a savings account but it is difficult to find information on fees on their website. BMO also offers a 1% rate on a savings TFSA and doesn’t levy any administration fee, withdrawal fee or transfer fee. CIBC’s savings account offers a 0.75% interest rate and charges no admin fee or withdrawal fee but transfers cost $100. President’s Choice TFSA isn’t very attractive either: a 0.75% interest rate and a $50 transfer fee.

After looking at RBC’s offering, I narrowed down the list to three options:

Outlook Financial, a Manitoba-based credit union, offers a High-Interest Savings Account with an attractive 1.50% interest rate and some of the best cashable GICs around. For instance, the rate on a 5-year cashable GIC (a minimum investment of $1,000) is 3.85% with a 2% interest rate for early redemptions. There is a catch though: Outlook Financial does not offer CDIC coverage. Instead, insurance is provided through the Credit Union Deposit Guarantee Corporation.

Once again, ING Direct has a very strong TFSA offering: a high interest savings account with a 3% interest (until October 1, 2009) that will probably change to 1.2% thereafter. The rates on GICs are also very attractive: 3% on a 5-year GIC with no minimum investment and an early redemption rate of 0.5%.

The TFSA from Canadian Tire Financial Services is also attractive with a 1.5% high interest savings account and cashable GICs. The website is not very clear on the early redemption rate only saying: “you will instead receive interest on the redeemed amount at the early redemption rate that we then pay on GICs of the same term”. Both ING Direct and CTFS have CDIC coverage.

I’m leaning towards ING Direct because I already hold an account with them and their offering isn’t markedly different from Canadian Tire. I’m planning to keep the TFSA contributions in a savings account for now and build a laddered GIC portfolio of 1 to 5 years at a later date. This topic was also posted on the Canadian Money Forum.

Related Reading:

• Savings Products from Canadian Direct, Peoples Trust and Ally
• Which Tax-Free Savings Account (TFSA)?
• Hubert: A new online savings bank
• ING Direct Lags the Competition
• 2010 Canada Savings Bonds on Sale Now

Choosing a TFSA Savings Account is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

1. It compares apples to oranges. Mr. Hamilton is comparing defined benefit (DB) plans with defined contribution (DC) plans. The two plans are completely different beasts and it doesn’t make much sense to compare just one narrow aspect of one plan with the other.
2. It will set a bad precedent. If the Government provides retroactive TFSA room to help recover from the losses of the current bear market, what happens when the next one comes along? What will investors demand next?
3. It presumes capital losses only by looking at the peak market values. Investors who are close to retirement should have a healthy allocation to bonds. They shouldn’t complain if they took on more risk to boost returns and got burned in the process. Also, if investors calculated their returns based on the amounts they invested over time and the current market value, they may not even show a loss. So, what exactly does the proposal plan to redress?
4. It doesn’t benefit the vast majority of Canadians. The person who benefits the most would be one who has no RRSP room and holds significant assets in a taxable portfolio. The vast majority of Canadians don’t fall in that category — they have plenty of unused RRSP room and simply don’t save enough to take advantage of any extra contribution room.
5. It is likely to be expensive. The proposal is likely to result in a significant loss of tax revenues. Budget 2008, which introduced the TFSA estimated that the savings plan will cost the government $3 billion annually in 20 years. I don’t know exactly how much the retroactive TFSA idea would cost but I won’t be surprised if it is comparable to the $3 billion estimate. It may seem insignificant compared to $250 billion in expenses but at a time when the Government is running big deficits, it doesn’t seem prudent to spend even more money.
6. It disproportionately favours older Canadians. TFSA, as it currently exists allows a gradual accumulation of contribution room over time. If it ever becomes too popular, the Government would look for ways to limit the advantages. For instance, the Government could mandate a maximum lifetime contribution limit. Providing retroactive contribution room in the name of fairness assumes that the plan would exist in its current form forever. It may not.
7. It unfairly affects younger Canadians. As noted earlier, the proposal is likely to result in a significant loss of tax revenue. The loss will be made up elsewhere — either current taxes or future taxes, which would be borne by younger Canadians.

Related Reading:

• This and That: Retroactive TFSA Contribution Room, Financial Literacy and more…
• FAQs on Tax-Free Savings Accounts
• Low savings, not RRSP Contribution Limits are the problem
• Ideas for your Tax-Free Savings Account (TFSA)
• 2010 Year-end Financial Deadlines

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