Investing in stocks in a TFSA
I have to say, this discovery is among the more perplexing.
So, I opened a TFSA account in which I was holding some stocks. At the present, the amounts are rather inconsequential. Most of my TFSA money is off in other accounts letting robo advisors handle it.
With the market having gone down a lot recently thanks to COVID-19, I felt this was a good opportunity to get into stocks. Right now, I have less than $400 in there. As I said, not a lot. After all, my primary stance is not to try and read the markets too much, which means, mostly, sticking to your plan if you had one. Otherwise, you could end up recklessly risking your money.
Then, I discovered that trading too actively in my TFSA could lead to the CRA treating the income as a business and wanting to tax me on the gains. So, I went to look for formal guidelines or recommendations. I can't seem to find any. In fact, I really can't say that the easily accessible online information even presents this as a potential challenge.
And yet, I can find articles about court cases on the topics. And also, part of the reason I can't find clear guidelines; the CRA refuses to establish any.
This is non-sensical.
TFSA stands for "Tax Free Savings Account". It is a place I put my after tax money, where they can grow without the gains being taxed. It is extremely limited. At the moment, the cap grows by just $6000/year. And, I'm allowed to allocate the money, basically, however I want. Savings accounts, stocks, mutual funds, etc...
First and foremost, the CLEAR intentional purpose of these accounts is to put them in places where the money will grow. And furthermore, grow decently quickly.
Why do I say that? Well, the "Tax Free" aspect of the account is pointless if there are no gains. As I said, this is after tax money we're putting in there. The government wouldn't have had a means of taxing it anyway. The taxes you can possible be made "free" of would be those on gains. And secondly, it would only be worth sheltering those gains if they are substantial.
I make next to nothing in interest on my checking account for example. Less than a dollar a year. Sure, the account is gaining money and that amount is taxable. But I'm really not concerned about that.
So, the only ways a TFSA actually offers value is if you can hoard a MASSIVE sum of money at low returns, or smaller amounts at higher returns. But, the annual limits stop the first scenario. In short, a TFSA only offers Canadians value if they can maximize their returns on that investment.
Enter stocks. The quickest way to make money, if you have the knowledge, the time and a little luck is buying and selling stocks. Except... this might cause the CRA to treat this behavior as running a business from your TFSA and force you to pay on the gains.
The problems for me are:
Starting with #1. The limits are quite restrictive. As I was already 18 when the system was introduced, I have the highest possible cap. A little less than $70k this year. If I were running this "as a business", and hoping to extract reasonable profits out of this, I would need, let's say $30k/year to call it a part-time job, or $60k a year for full time. Note that it also took 18 years for the cap to reach this point.
But, even if I started now, I'd need almost %50-100 annual gains to reach those numbers. And I would need to be able to maintain those numbers. But, more typical gains are more like 4-10%. So, even on the higher end, I'd still be pulling in less than $600 a month. And, if I were taking out all of my gains, that number would be growing year over year.
And this is silly to me because of #2. I get that the CRA may want to take these things on a case by case basis. But, it would be able to establish some simply guidelines. Like, let's say, more than 100 trades average per month, with gains equalling more than %25 of your outside income, with regular withdrawals of %10 or more of your outside income prompts an automatic review.
See what I did there? I've limited trading, which in turn would limit the amount of time spent on the activity and flexibility. Adding in additional limits on gains vs. external income helps restrict it further to people who might actually be able to rely on this income stream. And then lastly, if you're not taking the money OUT, then you're still growing it as savings. And, it is really hard in my mind for the CRA to justify penalizing people.
Thirdly, as I've said before. When you think about what a TFSA is, it really makes the most sense that this is where you would make your riskiest or most aggressive investments. Without clear guidelines, it seems like entrapment. The TFSA is a honeypot. It is really purpose designed to promote aggressive stock trading. But, it doesn't clearly state that this behavior could violate anything.
And, fourthly, as I've said, the only reason to put pre-taxed money into a tax sheltered savings account would be to grow it. To then turn around and penalize people for growing their money seems to violate the whole reason for the account existing in the first place.
And lastly, it doesn't really stop any of what I said above. You can still turn a TFSA into a hefty tax free source of ongoing revenue and effectively make it a second job. It would take time. But, so would playing the stock market. It just might take a little more time. The easiest way would be to put the money with a robo-advisor like WealthSimple or if your bank has one. Max out the contributions year after year in a fairly aggressive plan, and you'll probably earn 5-10% per year. And as long as you don't withdraw, it will compound.
With a little luck and time, your account could produce enough annual interest to live off of. I took a compound interest calculator, and plugged in $6k as my initial investment, with $6k added annually and a %10 rate of return (yes, optimistic to be sure) then, in 24 years, the account would be worth over $600k. That %10 return would now be more than the $60k I would need to replace my current income stream.
The only difference is, the growth potential is lower because I can't actively invest in the markets. But, at the same time, I've turned my TFSA into my livelihood without making a single trade.
And, what if I put that money into an account managed by someone else? I'm not making the trades myself or investing the time. In fact, that is really what these robo-advisors are doing. It is what an ETF is. Which is why I say that there are ways around this. If someone comes along and creates an insanely well performing ETF and you just park your money in there, then the CRA can't possibly do a thing about it. I'm not actively trading at all. And I'm allowed to hold ETFs in that account.
Again, I DO understand that the CRA may want to evaluate these cases individually. But, there are already restrictions in place. And some simple thresholds to trigger an audit would eliminate what seems like an elaborate trap to extort more taxes. It wouldn't eliminate confusion. Today, there is nothing to be confused over. The guidance available seems to ignore this topic entirely. Which is a large part of why I feel this is such a shady act.
So, I opened a TFSA account in which I was holding some stocks. At the present, the amounts are rather inconsequential. Most of my TFSA money is off in other accounts letting robo advisors handle it.
With the market having gone down a lot recently thanks to COVID-19, I felt this was a good opportunity to get into stocks. Right now, I have less than $400 in there. As I said, not a lot. After all, my primary stance is not to try and read the markets too much, which means, mostly, sticking to your plan if you had one. Otherwise, you could end up recklessly risking your money.
Then, I discovered that trading too actively in my TFSA could lead to the CRA treating the income as a business and wanting to tax me on the gains. So, I went to look for formal guidelines or recommendations. I can't seem to find any. In fact, I really can't say that the easily accessible online information even presents this as a potential challenge.
And yet, I can find articles about court cases on the topics. And also, part of the reason I can't find clear guidelines; the CRA refuses to establish any.
This is non-sensical.
TFSA stands for "Tax Free Savings Account". It is a place I put my after tax money, where they can grow without the gains being taxed. It is extremely limited. At the moment, the cap grows by just $6000/year. And, I'm allowed to allocate the money, basically, however I want. Savings accounts, stocks, mutual funds, etc...
First and foremost, the CLEAR intentional purpose of these accounts is to put them in places where the money will grow. And furthermore, grow decently quickly.
Why do I say that? Well, the "Tax Free" aspect of the account is pointless if there are no gains. As I said, this is after tax money we're putting in there. The government wouldn't have had a means of taxing it anyway. The taxes you can possible be made "free" of would be those on gains. And secondly, it would only be worth sheltering those gains if they are substantial.
I make next to nothing in interest on my checking account for example. Less than a dollar a year. Sure, the account is gaining money and that amount is taxable. But I'm really not concerned about that.
So, the only ways a TFSA actually offers value is if you can hoard a MASSIVE sum of money at low returns, or smaller amounts at higher returns. But, the annual limits stop the first scenario. In short, a TFSA only offers Canadians value if they can maximize their returns on that investment.
Enter stocks. The quickest way to make money, if you have the knowledge, the time and a little luck is buying and selling stocks. Except... this might cause the CRA to treat this behavior as running a business from your TFSA and force you to pay on the gains.
The problems for me are:
- The average person couldn't even abuse the system quickly and easily even if they wanted.
- It would be simple to establish rules or guidelines.
- The absence of such guidelines invites abuses.
- Such pressure violates the most logical reasons for creating such an account.
- The fact that it can be circumvented in other ways proves the insanity.
Starting with #1. The limits are quite restrictive. As I was already 18 when the system was introduced, I have the highest possible cap. A little less than $70k this year. If I were running this "as a business", and hoping to extract reasonable profits out of this, I would need, let's say $30k/year to call it a part-time job, or $60k a year for full time. Note that it also took 18 years for the cap to reach this point.
But, even if I started now, I'd need almost %50-100 annual gains to reach those numbers. And I would need to be able to maintain those numbers. But, more typical gains are more like 4-10%. So, even on the higher end, I'd still be pulling in less than $600 a month. And, if I were taking out all of my gains, that number would be growing year over year.
And this is silly to me because of #2. I get that the CRA may want to take these things on a case by case basis. But, it would be able to establish some simply guidelines. Like, let's say, more than 100 trades average per month, with gains equalling more than %25 of your outside income, with regular withdrawals of %10 or more of your outside income prompts an automatic review.
See what I did there? I've limited trading, which in turn would limit the amount of time spent on the activity and flexibility. Adding in additional limits on gains vs. external income helps restrict it further to people who might actually be able to rely on this income stream. And then lastly, if you're not taking the money OUT, then you're still growing it as savings. And, it is really hard in my mind for the CRA to justify penalizing people.
Thirdly, as I've said before. When you think about what a TFSA is, it really makes the most sense that this is where you would make your riskiest or most aggressive investments. Without clear guidelines, it seems like entrapment. The TFSA is a honeypot. It is really purpose designed to promote aggressive stock trading. But, it doesn't clearly state that this behavior could violate anything.
And, fourthly, as I've said, the only reason to put pre-taxed money into a tax sheltered savings account would be to grow it. To then turn around and penalize people for growing their money seems to violate the whole reason for the account existing in the first place.
And lastly, it doesn't really stop any of what I said above. You can still turn a TFSA into a hefty tax free source of ongoing revenue and effectively make it a second job. It would take time. But, so would playing the stock market. It just might take a little more time. The easiest way would be to put the money with a robo-advisor like WealthSimple or if your bank has one. Max out the contributions year after year in a fairly aggressive plan, and you'll probably earn 5-10% per year. And as long as you don't withdraw, it will compound.
With a little luck and time, your account could produce enough annual interest to live off of. I took a compound interest calculator, and plugged in $6k as my initial investment, with $6k added annually and a %10 rate of return (yes, optimistic to be sure) then, in 24 years, the account would be worth over $600k. That %10 return would now be more than the $60k I would need to replace my current income stream.
The only difference is, the growth potential is lower because I can't actively invest in the markets. But, at the same time, I've turned my TFSA into my livelihood without making a single trade.
And, what if I put that money into an account managed by someone else? I'm not making the trades myself or investing the time. In fact, that is really what these robo-advisors are doing. It is what an ETF is. Which is why I say that there are ways around this. If someone comes along and creates an insanely well performing ETF and you just park your money in there, then the CRA can't possibly do a thing about it. I'm not actively trading at all. And I'm allowed to hold ETFs in that account.
Again, I DO understand that the CRA may want to evaluate these cases individually. But, there are already restrictions in place. And some simple thresholds to trigger an audit would eliminate what seems like an elaborate trap to extort more taxes. It wouldn't eliminate confusion. Today, there is nothing to be confused over. The guidance available seems to ignore this topic entirely. Which is a large part of why I feel this is such a shady act.
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