Clients with large amounts in their TFSAs should consider paying their TFSA’s management fees from outside the account to preserve contribution room.
Paying those fees out of an open or non-registered account for many years can pay off, said Dany Provost, director of financial planning and tax optimization with SFL Expertise in Quebec. Doing so will keep more money in the TFSA, which itself will compound over time.
Provost also suggested that a client could arrange for their fees to be paid once a year, in December. That way, if the client doesn’t have enough liquidity in a non-registered account to pay the management fees, the client could withdraw the fee amount from their TFSA and be able to re-contribute the amount quickly: as of January 1 of the following year.
Provost said the strategy is most useful for clients who have significant assets in their TFSAs and who are likely to maximize their TFSA contribution room each year.
“It’s like picking up money from the floor. It’s interesting, but you don’t have to go crazy about it,” Provost said. “There aren’t many negatives [to the strategy], except for the administrative follow-up that goes with it. Some clients might find it too complicated.”
But the benefits can add up.
Provost provided an example of a client who has been eligible for the TFSA since its inception and maxed out their contribution room every year from 2009 to 2020 ($69,500). Including returns, the client’s TFSA balance in December 2020 was $80,000.
Suppose the client’s annual management fee for the TFSA remains 1% over the next 25 years and she pays her management fees from outside the TFSA instead of from within. Further assume that annual TFSA contribution room gradually increases to $10,000 over the 25 years due to indexing, that the client maxes out her contributions each year (and never makes withdrawals), and that the TFSA returns 4% each year in interest income.
As of December 2045, and assuming a constant 45% marginal tax rate, the client would amass an extra $15,500 in contribution room by paying the fees from outside the TFSA, Provost said.
Using the same assumptions, Provost calculated that the annual incremental contribution room added by paying fees from outside the TFSA would be $253 in year 10 and $1,934 in year 25 of the strategy.
“The tax savings will be lower if the return comes from capital gains and the comparison is made with a mutual fund,” Provost noted. “It’s interesting, but the tax savings, in the grand scheme of things, are often marginal given that most of the money remains tax-free. There is always a trade-off between the complexity and administration of this and what you can save in taxes.”
Nonetheless, the strategy can work for high-net-worth clients who won’t touch their TFSAs until they die. The additional contribution room “may be, at the beginning, a negligible amount per year, [but] the difference in accumulation can climb to several tens of thousands of dollars over long periods.”
Provost noted that management fees for an individual’s TFSA are generally not tax-deductible.
In 2019, the Department of Finance wrote in a “comfort letter” that it would recommend the minister amend the Income Tax Act’s definition of “advantage” to exclude the practice of paying for investment management fees from funds outside of registered plans, including TFSAs.
This was a reversal of a position first communicated in 2016, when a Canada Revenue Agency representation stated that paying registered plan fees from non-registered, or open, accounts would incur a tax penalty equivalent to the fee.