How to take advantage of the higher TFSA limit

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The increase in the annual Tax Free Savings Accounts contribution limit to $10,000 has taken these powerful savings vehicles to a whole new level.

At the old limit, they were something of a financial sideshow, albeit a popular one (10.7 million Canadians had a plan as of the end of 2013). The $5,500 annual maximum restricted their effectiveness as a tax shelter, especially when compared to the much more generous limits on RRSP contributions.

You can still put more into RRSPs, assuming you have the required earned income and are not over 71. But the increase in the TFSA limit makes them much more attractive and magnifies their tax saving and investment potential.

Under the new rules, which are effective immediately, Canadians 18 and older can contribute up to $10,000 a year to their plans. The limit is now set in stone; the indexing provision was dropped in the budget. That's not a great loss. According to my calculations, it would have taken about three decades of indexing to reach the $10,000 limit, assuming inflation runs at two per cent a year.

As things now stand, a couple with adequate income or savings can move $20,000 a year into their TFSAs. It has been argued by some that only the wealthy will be able to take advantage of this windfall but as I have pointed out in previous columns, that's not necessarily correct. Many Canadians, including lower and middle-income people, will be able to benefit from the change.

Here are some ways to take advantage of the enhanced TFSA program.

- Top up your 2015 contribution now. Although the budget has not been debated in the Commons, much less passed, the new limit is effective immediately. After some initial confusion, the Canada Revenue Agency confirmed that in a press released issued three days after the budget announcement. In it, the CRA said: "Financial institutions may immediately allow existing and new account holders to contribute up to the proposed maximum. The CRA will continue to work with financial institutions to ensure a smooth implementation of this new proposed measure."

So if you've already made a $5,500 contribution for this year, you can add another $4,500 to that right now. Do so. The sooner the money gets into your account, the faster the tax-free earnings begin to grow.

- Consider drawing down RRSPs. For many years, my advice was to leave RRSP money in the plan for as long as possible. This strategy deferred tax and allowed for the accumulation of more tax-sheltered savings. The advent of TFSAs, and now the increased contribution room, has changed the landscape. In some cases – but not all – it may be advantageous to withdraw money from an RRSP (or RRIF) and contribute the after-tax proceeds to a TFSA. This strategy would be advantageous in certain circumstances, such as:

* Avoiding the Old Age Security clawback. Canadians who are subject to this pay the highest tax rate in the country – their marginal rate plus 15 per cent until the required amount of OAS benefits (which may be 100 per cent of the entitlement) has been clawed back. RRSP withdrawals (and RRIF payments) count as income in computing the clawback threshold. TFSA withdrawals do not. Note that the clawback only applies if your income in 2015 will be more than $72,809.

* Reducing the GIS penalty. Lower-income seniors who are eligible for the Guaranteed Income Supplement lose 50 per cent of the benefit for each dollar of income received over the $3,500 exemption. Withdrawals from RRIFs/RRSPs count as income. TFSA withdrawals do not.

* Post-retirement income will be higher. It can happen. Someone who retires with a top-level defined benefits pension plan and then takes on a consulting job could end up making more money after retirement than before, putting him or her into a higher tax bracket. That means more tax will be paid on the RRSP/RRIF withdrawals than was deducted at the time of the original contribution.

* Post-retirement tax rates will be higher. Planning to move from Alberta to Nova Scotia for your retirement years? Your tax bill will soar, leaving you with a lot less money from your RRSP/RRIF withdrawals. Alberta's top marginal rate this year is 39 per cent. In Nova Scotia, it's 50 per cent. You're better off drawing down the RRSP now and moving the after-tax proceeds to a TFSA.

- Income splitting. It's always been possible to split income under the TFSA rules. The contribution increase just makes it more effective. There is no spousal TFSA (unlike RRSPs) but you are allowed to give your spouse the money to open his/her own plan

- Estate planning. One of the major drawbacks of the RRSP/RRIF system is that all remaining assets in the plans are taken into income in the year the last surviving spouse dies. This can result in a huge tax bill if the amount in the plans is considerable. In Nova Scotia, Quebec, and Ontario the tax rate on the remaining assets could be about 50 per cent.

The increased TFSA contribution limit provides an opportunity to move some of that money out of RRIFs and tax shelter it forever (TFSA assets are not taxable at death). Yes, you'll pay tax on the withdrawals now, but it will likely be at a much lower rate than if the entire plan is taken into income at death. Talk to a financial planner about the idea.

The bottom line is that the government's decision has made TFSAs much more versatile. Take advantage of the opportunity.