The Tax-Free Savings Account (TFSA) is one of the strongest tools wealthy people use for tax planning, retirement planning, and estate planning. The wealthy build a good understanding of the TFSA contribution room, transfer, and the possible scenarios that can trigger tax liability and use them optimally to reduce tax and maximize earnings. The devil lies in the details. A small difference in the way you invest can bring significant tax savings when it’s time to reap. Today, we will discuss these minor details of the TFSA.
Source: Getty Images
Three TFSA tactics wealthy people use
1. Max out on TFSA contribution before investing in RRSP
You may know that the contributions you make to the TFSA are from your after-tax income, and the withdrawals are tax-free. To save $200 in tax today, you end up making a $2,000 contribution to the Registered Retirement Savings Plan (RRSP) while not using your TFSA contribution limit. You end up sacrificing the bigger long-term gain for an insignificant short-term gain.
Think of it this way: a $2,000 RRSP investment will give you a $200 immediate return in the form of tax savings. Now, you cannot withdraw this amount tax-free. Suppose the $2,000 converts to $20,000 in 12 years, and you want to withdraw that amount. You end up paying tax on $18,000 investment income. Even if we take a 15% federal tax rate, the minimum tax liability is $2,700 on $18,000.
What do wealthy people do? They prioritize TFSA investments over RRSPs, as they know that present-day cash payment is way cheaper than a future-date payment on returns. If you invest $2,000 in a growth stock like Descartes Systems (TSX:DSG) through the tax-free savings account, it can earn you the $200 tax saved in less than a year and keep growing that money. Your $2,000 can become $4,000 in five years, considering the stock’s past record of generating a 20% average annual return.
Now is a good time to prioritize TFSA investments over RRSP investments and buy Descartes stock as it trades at a 16% discount from its 2025 high. The global trade war has delayed its 30% holiday season rally. However, the latest second-quarter earnings released on September 3 revived investors’ confidence, as the company maintained double-digit net income growth despite a challenging environment.
2. Estate planning with a TFSA: Naming a successor instead of a beneficiary
Never underestimate your investment. You read stories of Apple and Nvidia investors who became millionaires. Plan to pass on your TFSA to your loved ones in a tax-efficient manner.
If you have a spouse or common-law partner, consider naming them as a successor instead of a beneficiary in your TFSA account. You may think they are just fancy words, but they have significant tax implications.
A beneficiary gets the TFSA money, while a successor gets the TFSA account. After your death, the TFSA is rolled over to your successor without affecting their TFSA contribution room. Your successor can make tax-free withdrawals from your TFSA just like you and need not pay probate fees or fill out any forms. However, the successor can only be a spouse or common-law partner.
If you make your spouse a beneficiary, they will have to file the RC240 form within 30 days of transferring the money from your TFSA. Failure to do so will remove the TFSA benefits.
Suppose Anna’s TFSA balance was $80,000, and she made her spouse, Jacob, a beneficiary, who had a TFSA contribution room of $20,000. After Anna’s demise, Jacob can transfer the money to his TFSA without affecting his contribution room. But if he fails to file the RC240 form on time, he will lose out on the $20,000 contribution room and face a 1% penalty per month on the $60,000 surplus. This is not the case with successors.
3. Retirement planning
Maxing out on TFSA contributions and withdrawing more from this account instead of RRSP will give you a tax-free pension. You can plan how much money to withdraw from RRSP and TFSA so that your taxable income is below the Old Age Security (OAS) income threshold. If your 2024 world income was less than $148,451, you can get the maximum monthly OAS of $734.95. Careful calculation and balanced withdrawal can help you get the maximum OAS payout.
