Using a TFSA to save for children's college?

eortlund · Post by **eortlund** » Mon Jul 20, 2009 7:20 am

I understand the RESP is problematic, especially in terms of reporting to the IRS. But my oldest child is 5 years old now, and I feel like I should be doing something to save for my kids' college education. As an American in Canada, I was wondering about using a TFSA. I know it is not tax exempt in either country, however, I am assuming that by using a foreign tax credit on my US taxes as I do, I would not owe anything to the US.

Or is there a better option out there?

nelsona · Post by **nelsona** » Mon Jul 20, 2009 12:45 pm

A TFSA is tax exempt in canada of course, otherwise the TF in TFSA would be meaningless.

Regardless of what you use it for, everyone living in Canada should be funding a TFSA. Period.

eortlund · Post by **eortlund** » Mon Jul 20, 2009 2:37 pm

What are the implications for reporting a TFSA's earnings to the IRS? I seem to recall a discussion here in the past about the IRS not recognizing it as tax-free.

nelsona · Post by **nelsona** » Mon Jul 20, 2009 5:19 pm

Its simply that: not tax-free, so you reprt the income earned in it. But that is all, no trust account reporting.

eortlund · Post by **eortlund** » Mon Jul 20, 2009 8:30 pm

Thanks--are you saying it is no different than how I currently report the interest earned on a basic Canadian savings account?

nelsona · Post by **nelsona** » Tue Jul 21, 2009 5:06 am

Yes, or any other investment account that is not sheltered.

eortlund · Post by **eortlund** » Tue Jul 21, 2009 7:08 am

Thanks! I think I will definitely look into starting one.

bruce · Post by **bruce** » Sat Jul 25, 2009 10:06 pm

Even though the TFSA is "tax free" in Canada and taxable in USA, I believe you should be able to lump any income from a TFSA with other non-sheltered Canadian-sourced passive income for the purposes of applying tax credits on your 1040 (via form 1116). So for most people, the TFSA is unlikely to cause any extra US tax. I guess the exception would be for those that have little or no other passive Canadian income. Is my understanding correct?

nelsona · Post by **nelsona** » Sun Jul 26, 2009 12:25 pm

Yes, the TFSA, in the eyes of IRS, is just another investment account, and is included with all other foreign passive income.

I see no reason why anyone in canada, including US taxpayers would not use a TFSA to the full extent, even if, due to the vagaries of foreign tax credits, some extra tax would be owed in US.

bruce · Post by **bruce** » Sun Jul 26, 2009 4:14 pm

I'm thinking about this a bit more and wondering whether being a US citizen changes the type of investments that should be held in a TFSA versus RRSP, taxable account, etc.

For a non-USC, foreign stocks seem like a good choice of TFSA investment because there is no tax on the dividends nor the capital gains. On the other hand, all things being equal, a USC may be better off holding GICs in the TFSA and the foreign stocks elsewhere (either taxable account or RRSP). My logic here is that a USC will declare GIC income on his/her 1040 each year and eliminate tax with other Canadian source passive income and there is no potential for a big capital gains hit years down the road. If a USC has a big capital gain in their TFSA, they may not have enough other Canadian-sourced passive to offset the US tax. Does that make sense?

nelsona · Post by **nelsona** » Mon Jul 27, 2009 4:03 am

Well, it is generally better to have investments that are taxed at regular income rates inside a sheltered account while capital items are held outside.

But if one's age and investment style is not to buy GICs, then ensuring that one has sufficient non-TFSA investments would be sufficient to avoid extra tax. One need to be tied to a particular investment pattern just to avoid US tax, since the goal of all investment is to produce income, taxable or not.

Think of this. If you have GICs in your TFSA and stocks outside, what will happen in a year when you make no stock trades? You would pay US tax on your TFSA GIC income, no?

bruce · Post by **bruce** » Mon Jul 27, 2009 6:44 am

Good point. I guess I was thinking of a situation where an investor also has a fair amount of unsheltered interest and dividends (especially given how small the TFSA room is). And then, at the margin, what do you move into the TFSA (without changing the overall asset allocation)? So the assumption here is that every year there will be enough tax on taxable interest & dividends to offset the relatively small amount of additional GIC interest in a TFSA. With this strategy, the USC could potentially avoid additional US tax on capital gains in the future. It's a relatively minor point but I can imagine how a USC might employ a slightly different strategy than a non-USC.

nelsona · Post by **nelsona** » Mon Jul 27, 2009 6:57 am

For US taxpayers, the goal should simply be to *mirror* your TFSA and non-TFSA investments, which I suppose is slightly different than what a non-US investor might do. This will ensure enough Cdn tax to cover your US tax -- if that is indeed important (?). Don't forget the FTC carryforward and carryback rules that will even out the yearly differences.

But, if you have no non-sheltered investments (most Cdns will fully fund their RRSP, their TFSA, and their principle residence -- in that order -- before investing outside), then your TFSA will be taxed in US regardless of what you put in it.

But, so what? It will still be less than the tax you would pay without a TFSA.

eortlund · Post by **eortlund** » Mon Jul 27, 2009 8:46 am

Trying to understand these last few posts. We are in that category of people who just have a house, RRSP, and hopefully a TFSA. I assumed the foreign tax credit would mean no tax payable to the US, or little.
But now I'm wondering--if I don't owe Canada any tax for the TFSA earnings, how would I take a US foreign tax credit for them?

eortlund · Post by **eortlund** » Mon Jul 27, 2009 8:48 am

We do have quite a few carried forward tax credits.

But I hoping to invest in the TFSA for growth--hoping it grows well.