Let’s say you are a high-income retiree with $10,000 of stocks purchased for $5,000. If you sold the stocks for a $5,000 capital gain, the tax payable might be $1,250 (assuming taxes of 25%). If the alternative was a tax-free TFSA withdrawal, that might seem like the better option at first. However, taking an equivalent $8,750 withdrawal from your TFSA—to yield the same $8,750 after tax as the $10,000 non-registered stock sale—gives up future tax savings in that TFSA.
If we consider a Canadian stock paying a 2.5% dividend, the annual tax savings in a TFSA might be $87.50 (for the same high-income retiree, assuming 40% tax on Canadian dividends). Is it worth paying $1,250 in capital gains tax today to sell the non-registered stocks to save $87.50 per year of tax on dividends in a TFSA?
The dividend tax savings are not the whole story, though. If we assume 4% capital growth for the stock, there may be another $87.50 of deferred capital gains tax saved per year. Is it worth paying $1,250 in tax today to save $87.50 of tax per year and $87.50 of deferred tax per year?
It bears mentioning the $87.50 of dividend tax saving and $87.50 of deferred capital gains tax saving will compound over time. And a dollar of tax saved today is more valuable than a dollar saved in 10 years due to the time value of money. So, the math is not as simple as calculating that, after eight years, there will be more tax saved by keeping the TFSA stock invested.
Some general rules to follow
There may be a break-even calculation depending on a ton of different factors, Catherine, including:
- Your current and future tax rates
- Your investment risk tolerance
- Your age
- Your life expectancy
- Your spouse’s life expectancy
As a rule of thumb, I would consider non-registered withdrawals over TFSA withdrawals under the following circumstances:
- You are in a high tax bracket.
- You could be in a higher tax bracket in the future.
- You or your investment advisor frequently sell and repurchase stocks.
- You have cash in your non-registered account.
- You have modest capital gains in your non-registered account.
- You are relatively young.
- You have a relatively long life expectancy.
- You have a spouse with a relatively long life expectancy.
Ultimately, there are no perfect decumulation rules in retirement, Catherine, and you need to consider a bunch of factors. Using financial planning software, you can try to model different scenarios to see the potential impact on after-tax retirement income and after-tax estate value.
In some cases, taking TFSA withdrawals over non-registered withdrawals may make sense, especially if you have large deferred capital gains on your non-registered investments. Deferring those capital gains at all costs could be the wrong choice, though, especially if it means having concentrated positions in only a few stocks, which makes your portfolio less diversified. So, tap your TFSA and defer your non-registered capital gains tax cautiously, if at all.