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How to cushion the loss of the $10,000-a-year TFSA limit

TFSA lovers, you need a distraction after an outcome in the federal election that suggests the current $10,000 annual contribution limit is toast.

Let's talk taxes. If tax-free savings accounts go back to the old $5,500 limit - as the Liberals had vowed to do in the lead up to the election - you may find yourself with money to invest in taxable accounts. Reminder: Dividends and capital gains are taxed quite advantageously. They're not tax-free, but the actual tax rates are well below what you'll pay on regular income or bond interest.

Here's a toy for you – the 2015 personal tax calculator from Ernst & Young. Plug in your taxable income and the calculator shows you things like your average tax rate and your marginal tax rates overall and on capital gains and dividends. Let's use the example of someone who makes $150,000 and, as a result of the expected TFSA limit change, will be investing in a taxable account. The marginal tax rate on capital gains ranges from a low of 19.8 per cent in Alberta to a high of 25 per cent in Quebec. How advantageous is that? The overall marginal tax rate for Albertans who make $150,000 is 39.5 per cent, while the comparable number in Quebec is 50 per cent. Note: The inclusion rate on capital gains is 50 per cent.

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Dividends are also taxed with a lighter hand than regular income, but the difference is less dramatic in most cases than it is with capital gains. Across Canada, the marginal tax rate on eligible dividends (from big companies) ranges from 20 per cent in Alberta to 35.2 per cent in Quebec.

Dividends become very interesting if your taxable income comes in below $45,000. The E&Y calculator shows that at $44,000 in taxable income, eligible dividends have a marginal tax rate of zero in British Columbia, Alberta, Saskatchewan and Ontario. In New Brunswick and Prince Edward Island, the rate on dividends at that income level is just below 5 per cent.

Losing the higher TFSA limit smarts because of the loss of tax-free investing room and the simplicity of being able to invest a large sum without the headaches of book-keeping for tax purposes. But the tax hit on capital gains and dividends is at least cushioned a bit.  Keep this in mind when plotting your investing strategy for a back-to-the future TFSA limit of $5,500.

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