The Scoop On TFSAs

Tax Free Savings Accounts, or TFSAs, have come along at a perfect time for those of us who invest or trade in speculative resource stocks. Introduced in last year’s federal budget, TFSA’s came into effect on Jan. 1, 2009, and to me, they are an ideal account for aggressively pursuing capital gains.

I assume the banks and most financial advisers will probably want to steer you towards more conservative investments, but for the amount of money currently involved and your ability to use Registered Retirement Savings Plans (RRSPs) to shelter other investments, TFSAs should be used for your more speculative trades for now.

To be fair, I have to remind you that if you lose money in a TFSA, you cannot use any of the capital losses for tax purposes. In some ways, that may be good in that it means you need to spend the time to find low-priced stocks that have the highest odds of appreciating — you will have to do a little bit more research or get after your broker to dig this out for you.

In addition, you should not get too greedy when in a profit position. Maybe this will be a good incentive to set up a predetermined trading strategy and stick with it rather than riding a stock up and all the way back down again as most of us have done at one time or another.

Because of the big meltdown in stock prices over the last year, it should be easy for us to find a large number of lower-priced stocks. Then we will have to use filters to try to eliminate those that deserve to be cheap and will continue to wither away, and those that have high odds of at least doubling or tripling from their depressed levels.

Over the last six months, most of the senior and mid-tier precious metals stocks have taken a run up without much of a follow-through in the lower-tier ones.

The same should happen over time in the base metals, uranium, potash, oil and gas stocks some time later in the cycle.

Usually, this will translate into price appreciation in the lower-tier stocks as a rotation begins from the fully priced stocks in a sector to the cheaper stocks that haven’t moved yet.

Here are the basic criteria I use along with my 40 years of market experience to come up with a list of stocks: enough cash to still be around a year from now; shares trading at or near the lows for the last few years; a fairly low number of outstanding shares so that the danger of a roll-back is not imminent; management and insiders have a stock position large enough to make them want to make a go of it; management has had previous success in both the market and their business; a viable project, whether it’s a resource property, an oil and gas prospect, or a concept.

Some other points to remember about TFSAs:

• Any amount withdrawn from the TFSA is available as a new contribution amount for the next year.

For example, suppose you contribute the maximum $5,000 and are lucky enough to buy a stock that goes up substantially and you manage to sell it for $15,000. In this case, if the $15,000 is withdrawn from the TFSA account tax-free, then a $20,000 contribution amount is available to you for the next year. This new contribution amount is the total of the amount withdrawn ($15,000) plus the annual limit ($5,000). However, the reverse would also be true: if you contribute and invest $5,000, and then lose $4,000 and withdraw $1,000, then the next year’s contribution room would only be $6,000.

• I understand that a number of brokerage firms have asked for a tax ruling regarding warrants, as many people are wondering what the rules are regarding contributing the warrants from a unit financing to the TFSA. When a ruling is given, I will put it up on my website and into my newsletter, TFSA Investment Letter.

Finally, here are the basics of the TFSA as issued from the Taxpayer Services Directorate at Canada Revenue Agency (CRA):

• Contributions to a TFSA are not deductible for income tax purposes, and the income earned in the account (for example, investment income and capital gains) is tax-free, even when it is withdrawn. Interest on money borrowed in order to contribute to a TFSA is also not tax-deductible.

• The types of investments that will be permitted in a TFSA are the same as those permitted in a registered retirement savings plan (RRSP).

• You can also make “in kind” contributions to your TFSA, as long as the property is a qualified investment (for example: money; interest that is paid, or payable, on a bond, mortgage, note, debenture, or other debt obligations; guaranteed investment certificates (GICs); and investment contracts.)

You will be considered to have disposed of the property at its fair market value (FMV) at the time of the contribution. If the FMV is more than the cost of the property, you will have to report the capital gain on your income tax return. However, if the cost is more than the FMV, the resulting capital loss cannot be claimed.

• You can contribute up to $5,000 annually to your TFSA. After 2009, the annual TFSA dollar limit will be indexed to the inflation rate, and rounded to the nearest $500. For example, assuming that the inflation rate is 2%, the TFSA dollar limit would remain at $5,000, for 2010 and 2011, but would increase to $5,500 for 2012.

• TFSA contribution room is made up of: your annual TFSA dollar limit ($5,000 per year plus indexation, if applicable); any unused TFSA contribution room in the previous year; and any withdrawals made from the TFSA in the previous year, excluding qualifying transfers (i. e., a direct transfer between TFSAs of the same holder, or the amount that is transferred directly to a spouse or common-law partner or former spouse or common-law partner if the transfer relates to a division of property due to the breakdown of the relationship.)

• Based on information provided by the issuers, the CRA will determine the TFSA contribution room for each eligible individual. Your annual contribution room will be indicated on your notice of assessment. Withdrawals, excluding qualifying transfers, made from your TFSA in the year will be added back to your TFSA contribution room at the beginning of the following year. You cannot contribute more than your TFSA contribution room in a given year, even if you make withdrawals from the account during the year. If you do, you will be subject to a tax equal to 1% of the highest excess amount in the month, for each month you are in an over-contribution position.

• Neither income earned in, nor funds withdrawn from a TFSA will affect your eligibility for federal income-tested benefits and credits, such as the Working Income Tax Benefit, the Goods and Services Tax Credit, the age amount and the Canada Child Tax Benefit. These amounts will also not reduce other benefits that are based on your income level, such as Old Age Security benefits, the Guaranteed Income Supplement, or Employment Insurance benefits.

• When there is a breakdown in a marriage or common-law partnership, an amount can be transferred directly from one former spouse or common-law partner’s TFSA to the other’s in the following situation: You and your current or former spouse or common-law partner are living separate and apart at the time of the transfer and you are entitled to receive the amount under a decree, order, or judgment of a court, or under a written separation agreement; and to settle rights arising out of your relationship on or after the breakdown of your relationship.

The amount of the transfer will not reduce the recipient’s eligible contribution room; however, since this transfer is not considered a withdrawal, the transferred amount will not be added back to the transferor’s contribution room at the beginning of the following year. The transfer will not eliminate any excess amount in the TFSA.

• In the case of death, the deceased holder is not considered to have received an amount from the TFSA at the time of death if, in the TFSA contract, the holder named his or her spouse or common-l
aw partner as the sole beneficiary of the TFSA. In this situation, the TFSA continues and the spouse or common-law partner becomes the new account holder.

–The author has more than 40 years’ experience in the investment business on the brokerage side in retail, research, institutional and trading, on the public company side as a director and adviser, and in financing and marketing. He is editor of TFSA Investment Letter (www.tfsainvestmentletter.com)and Cuban Weekly News Digest (www.cubaninvestments.com).