DRIPs and the TFSA

How to take advantage of the TFSA with DRIPing

Goal: Take advantage of fractional dividend reinvestment & free share purchases of a DRIP/SPP then at some point move shares to a TFSA to shelter future gains from taxes.

Please read carefully start to finish.

In 2008 the Canadian government announced a new method for saving and investing, the TAX FREE SAVINGS ACCOUNT (TFSA or pronounced 'Tiff-Suhh' by some). Similar to its older, wiser cousin, the RRSP, the TFSA allows an investor to have an account where any gains (e.g. any profits) that are earned inside the account(s) do not incur any tax. 

 Another similarity between the TFSA and RRSP is that there are limits to how much you can contribute to the account.

For your RRSP, your limit is 18% of your previous year's "Earned Income" plus any unused room from previous years.

 Currently the TFSA contribution room and past years are listed on Canada.ca. 

But there are 2 significant differences between the TFSA and RRSP:

1.) Taxation: The RRSP is funded by PRE-TAX dollars, and the TFSA is funded with POST-TAX dollars. 

For every dollar you put into a RRSP account, the Government refunds you the income tax paid on that dollar, which is based on your Marginal Tax Rate in the year you claim that RRSP contribution. Then when you retire, all money deposited and all profits are taxed at your Marginal Tax Rate as you withdraw it.

For every dollar you put into a TFSA account, the Government has already taxed you on that dollar.  So when you withdraw any money or profits from a TFSA account, no tax is paid by you.

2.) Withdrawals:  The Government was to discourage investors from withdrawing funds from their RRSP since it is intended to be used in retirement years.  Withdrawals from an RRSP (unless in specific cases) will be assessed a withholding tax based on the amount, and even more if that doesn't cover your marginal tax rate for the year of withdrawal on your tax return.

Taking ANY money out a TFSA (original funds or any gains) account does not incur any tax.  Your total room for contributions doesn't increase for the amount withdrawn until Jan-01 of the following year.  So therefor, you want to respect the remaining contribution room you had BEFORE the withdrawal until December 31st.

RESULT:  For those looking for flexibility, keeping feels low or zero, don't mind doing an extra step or two from their regular DRIPs and expect their income to remain flat through out their life, then MAY be the following DRIP + TFSA Strategy is for you.

The Strategy is simple:  Use the free nature of DRIPs and SPPs to build small positions in a stock, then transfer a block of the shares to a discount broker who offers a free synthetic DRIP and accepts deposits 'In-Kind' for free thus continuing your holdings while future gains are sheltered from tax and keeping expenses to a minimum.

STEP BY STEP:

1.) Start investing in a Canadian company through their DRIP & SPP as per the Canadian DRIP Primer.  Ensure this company's plan has a share purchase plan.  It's a MUST it has a SPP that allows for Monthly purchases.

2.) Open a Canadian Discount Brokerage account that offers a.) Free Synthetic DRIP and b.) accepts deposits of shares "in-kind" meaning without selling them and re-buying them, and for free.   For a.) it would be a benefit if they honoured any DRIP discount offered by the company and in general it be good if they did not have any fees for withdrawals or account inactivity.  Double check with your potential broker that they offer the above.

3.) Build your position in the company selected in #1 as quickly as you can, with an emphasis on larger than normal optional cash purchases. At the same time not to large as to surpass your TFSA contribution limit as noted above.

4.) Depending on the stock price, aiming for 25, 50 or 100 shares is a good goal.  Once you've reached goal in your DRIP account holdings, request a stock certificate for the desired share # from the Transfer Agent, this is free.  Generally you have to write or fax the transfer agent to request the certificate.

5.) Send the certificate to your discount broker indicating you want it deposited 'In-Kind' (I.e. you want them to remain as shares) to your TFSA.  Some brokers require a form.  Call the broker and find out.

6.) ** Slightly Complicated Tax Part Ahead - Don't be Scared **

  Since you plan on moving some shares you own from a 'Non-Registered' or 'Taxable' holding with the transfer agent to a TFSA, you MAY incur taxes.  The beancounters over at CRA consider this move a "Deemed Disposition" which means "we consider that you sold them and re-bought them."   So any profits made at that time will require you pay capital gains tax.  If they are transferred over at a loss, you cannot claim that as a capital loss. 

  When your deposit the share certificate into your TFSA, you will need to know the Adjusted Cost Base (ACB) per Share for your holdings in the DRIP.  See more here on this page on calculation ACB per Share.  Then, ideally, to reduce the tax impact, your ACB per Share will be close (+ / - )  to the current trading price for the stock when you deposit your shares.  Most brokers require you have a 'taxable' trading account which acts as a middle man before moving it over to the TFSA.

    Have your broker move the shares into your TFSA Account.  It is a this point for tax purposes you are required to know your ACB per Share and the deemed Share Price (usually closing share price on that day) a the time of the deposit.  If there is a gain, you are required to declare it on your income taxes.

7.) With the shares now in your TFSA, enroll them in your broker's Synthetic DRIP program. Depending on how many shares you deposited and the current dividend per share for the stock, you many not have enough right away to purchase a whole share with the Synthetic DRIP. 

8.) Repeat the process with the same or another company, so long as you respect your TFSA contribution limit. 

   To keep trading fees and commissions low, try to anticipate when you will need money by turning off the Synthetic DRIP and let cash accumulate in your TFSA broker account to be withdrawn whenever you want.  Choosing a broker who offer TFSA withdrawals free of charge is important for this

But you ask, why do it this way?

By building your positions in your TFSA by doing the above process and through your Broker's Synthetic DRIP, you will grow your holdings with very little fees, and all future gains will not be subject to tax!

You take advantage of Dollar Cost Averaging:  Your share purchases through the DRIP & SPP and pay no fees to do that, so every one of your dollars works for you.  Then, by taken advantage of the TFSA and it's flexibility of deposits and withdrawals, and future proofing by sheltering your profits and dividends from tax, all money earned goes to you!