Helping clients allocate their assets tax-efficiently to various registered and non-registered accounts is a challenge. And the introduction of the tax-free savings account in January adds another layer of complexity.

The TFSA will provide a new vehicle for savings that shelters investment growth from taxes. Because TFSA contributions and the income they earn can be withdrawn at any time tax-free, the TFSA will probably bring changes to the way in which you deal with your clients’ equities and interest-earning securities to take advantage of the income tax system.

With an RRSP, all withdrawals are taxed at the planholder’s marginal tax rate. That means favourable tax treatments on investments, such as capital gains and dividend tax credits, are lost. Meanwhile, interest income generated in non-registered accounts is taxed at the client’s marginal rate, but capital gains and dividends attract the special treatment.

Of course, tax-efficient investment planning is just one facet of overall financial planning, and should not be considered in isolation.

“Just because investments are in a TFSA, and the tax treatment of the investments is much more beneficial [than in non-registered accounts],” says Sam Febbraro, president and CEO of Mississauga, Ont.-based Counsel Wealth Management, “an advisor and a client cannot lose sight of their asset-allocation strategies.”

For high net-worth clients, the task of allocating assets tax-efficiently is particularly complex. Assuming that HNW clients are able to max out their contributions to registered accounts, they will have to place some of their funds in unregistered accounts.

In many cases, it may be better if clients focus on holding equities in non-registered accounts, as capital gains and dividend income generated by equities are taxed at lower rates than other types of income. Any capital gain or dividend income earned in an RRSP would be taxed at the same rate as interest income, which receives no special tax treatment, when withdrawn.

It’s important to keep in mind, too, that a capital loss can be written off or offset against capital gains when earned in a non-registered account. Capital losses can’t be claimed when realized inside a registered account such as an RRSP.

Fixed-income investments, on the other hand, are ideal for either a TFSA or an RRSP, given that interest income generally receives no special tax treatment. Fixed-income investments are also appropriate if the money held within a TFSA is intended to be used for a short-term goal, such as buying a new car or simply to serve as an emergency fund.

Money withdrawn from a TFSA doesn’t have to be added to income, and the amount withdrawn is added to contribution room for the next year.

“In the short term, from an asset-allocation perspective, we’re probably looking at high-interest-savings accounts, GICs, money market funds, things of that nature,” Febbraro says, listing ideal investments for a TFSA.

“What is the source of the money [going into TFSAs] — at least, in the initial stages — going to be?” Febbraro asks. “Most advisors will probably suggest to a client: ‘If you have extra money in your bank account, let’s put it into the TFSA.’ If that’s how the discussion between the advisor and client starts, then fixed-income products will probably be used in the beginning.”

However, higher-growth investments also have their place in a TFSA and, in fact, some experts suggest that such assets, rather than those that generate mostly interest, have more room to grow inside a TFSA.

“If my assumption is that my equity investments will return my largest overall annual return — that is, will grow to the greatest amount over time,” says Jason Safar, a partner in the tax services practice of PricewaterhouseCoopers LLP in Mississauga, Ont., “then it makes sense that I would want those equity investments held inside my TFSA.”

The least tax-efficient program from which to withdraw a substantial investment gain is the RRSP (or RRIF), in which all withdrawals are taxed as income and could affect income-tested benefits such as old-age security. TFSA withdrawals, on the other hand, do not affect eligibility for the guaranteed income supplement or OAS benefits.

“We’ve been letting people know that the TFSA can be used for a variety of short- or long-term goals,” says David Birkbeck, head of registered products strategies with Royal Bank of Canada in Toronto. “That broadens people’s perspective. There are so many planning opportunities with a TFSA beyond [it being] a short-term savings account.” IE