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Everything You Ever Wanted to Know about TFSAs

TFSA stands for Tax-Free Savings Account, and that’s where a lot of the trouble with understanding its purpose lies.

A typical savings account is a banking product in which you store money that you don’t intend to use very often. These accounts typically have higher interest rates than chequing accounts but are harder to withdraw from. Interest rates vary but are usually very low.

A TFSA is not a typical savings account. It’s actually an investing account. Instead of putting cash into it, you put in securities – stocks, bonds, ETFs, mutual funds, etc. You are also allowed to put cash in, but that largely defeats the purpose of a TFSA.

If you have investments outside of a registered account (such as an RRSP or TFSA) you’re taxed on one of the following (read more about each by following the links):

1.       Interest

2.       Capital gains

3.       Dividends

No matter what type of investment you have, you will be taxed on one or more of these eventually. If the investment is in a TFSA, however, there is never any tax. Of any kind. Ever.

 

So what’s the catch?

There is a limited amount of contribution room in your TFSA. Every year, the Canadian government decides on how much you’re allowed to contribute to your TFSA. This amount is retroactive, so long as you were the age of majority for the years the TFSA has been active. If you’re 17 or younger, you have no room in your TFSA, but will start gaining room the year you turn 18. If you turned 18 after 2009, you’ll have some room, but not the full amount you may see online. Finally, if you were 18 in or before 2009, you’ll have the full amount of contribution room, regardless if you have even opened a TFSA before.

Here is a list of every contribution limit since inception.

Year

TFSA Annual Limit

TFSA Cumulative Limit

2009

$5,000

$5,000

2010

$5,000

$10,000

2011

$5,000

$15,000

2012

$5,000

$20,000

2013

$5,500

$25,500

2014

$5,500

$31,000

2015

$10,000

$41,000

2016

$5,500

$46,500

2017

$5,500

$52,000

2018

$5,500

$57,500

2019

$6,000

$63,500

Remember, you’ll only have $63,500 of contribution room if you were 18 in or before 2009.

Here’s the list for your cumulative limit for the year you turned 18.

Turned 18 in

TFSA Cumulative Limit

2009 or earlier

$63,500

2010

$58,500

2011

$53,500

2012

$48,500

2013

$43,500

2014

$38,000

2015

$32,500

2016

$22,500

2017

$17,000

2018

$11,500

2019

$6,000

 

What is a contribution?

A contribution is any amount of money you put in your account and that includes the dollar value of any securities.

Let’s assume that you have a contribution limit of $5,500. If you have 10,000 shares of a company valued at $4 each, you can’t put all of them in your TFSA at once because the value of all your stock is $40,000. You can, however, contribute a portion of the stock. 1375 shares have a value of $5,500, which you can add to your TFSA. Any more contributions will have to wait until the next year.

 

Is the contribution limit prorated?

No. If you turn 18 on December 31st, you will still have access to the full contribution limit for that year. However, you will be unable to open a TFSA until the day you actually turn 18.

 

Do contributions reset?

Yes. If you make a withdrawal, the amount you took out will be added as contribution room for next year. This is tied directly to the amount you withdrew, not the amount you initially contributed. 

Keep in mind that withdrawals are added to next year’s contribution limit. You can’t re-contribute immediately.

 

Is my contribution limit tied to my income?

No. Unlike an RRSP, where your contribution limit is linked to your income (18% up to a cap), the TFSA contribution limit is the same for all Canadians regardless of income. Even people with no income qualify for TFSAs.

 

Is the contribution limit indexed to inflation?

Yes. If you were thinking about this question, then you are quite the savvy investor.

Inflation is the reason that a coffee costs $1.77 now instead of a nickel like it did back in the ‘40s. As such, many years down the line, $5,500 may not be a lot of money at all. 30 years ago, $5,500 was the equivalent of $10,384 in today’s money.

As time goes on and money becomes more devalued, the TFSA limits will increase, then round to the nearest $500. We’ve already seen this happen when the limit was increased from $5,000 to $5,500 in 2013, to $6,000 in 2019.

 

Is there a penalty for over-contributing?

Yes. If you add more to your TFSA than your contribution limit allows, you’ll be subject to a penalty until either you take the over-contributed amount out or more contribution room becomes available (i.e. wait until January 1st).

The penalty is 1% of the over-contributed amount per month and is due at tax-time. If you over-contribute $1,000 on January 1st without realizing and leave it in there, your total penalty would be $120.

The good news is that the CRA can be willing to forgive this penalty if the error was found to be made by accident.

 

Is there a maximum amount of money I can hold in a TFSA?

No. There is a limit to how much you can contribute but the investments held within can grow to any value. A couple even had TFSAs worth $1 million, but the stock they owned has since plummeted in value. Always remember that investing carries risk.

 

Am I only allowed to have one TFSA account?

No. There is no limit on the number of TFSA accounts you can have, but your total contribution limit does not change. No matter how many accounts you have, your contribution room is the same. If you have three TFSA accounts, but put the full contribution limit into only one, you’re out of contribution room for all your accounts.

It can be advantageous to have more than one TFSA at different institutions because of rules based around buying, selling, and transferring stocks, ETFs, and mutual funds. If you have a TFSA at the same brokerage you bought your stocks from, it’s easy to transfer them into a TFSA. If you only have a TFSA at a bank, however, transferring stocks into your bank’s TFSA may not be allowed. Some banks may also charge you when you transfer a TFSA to or away from them. Check the restrictions at your institution.

 

Can I put any investment into my TFSA?

Yes and no. You are allowed to hold nearly any investment in a TFSA, but the institution that holds your TFSA may have rules that prevent certain investments from being put in. A bank may not allow third-party exchange-traded funds (ETFs) to be put inside and only allow their own funds.

Since you are allowed to have any number of TFSAs, if one institution doesn’t allow for a specific investment you’d like to make, you can always open another one at an institution that will.

 

Where can I open a TFSA?

You can open a TFSA at any bank or credit union, as well as other select financial institutions that handle investments like insurance companies and trust companies.

 

Is transferring existing investments into a TFSA taxable?

Yes. Transfers into a TFSA may trigger a taxable event – capital gains. A capital gain is when you sell something for more than you bought it for.

The reason you’re taxed when moving investments into a TFSA account, even though you aren’t selling it, is because the growth wasn’t tax-sheltered yet. You can’t cheat the system by holding a bunch of investments outside of your TFSA and moving them in tax-free as contribution room opens up.

If your investments have gone down in value by the time you transfer them into your TFSA, you cannot claim capital losses. Capital losses can only be claimed on non-registered investments, as they can be used to offset capital gains tax; and we know that capital gains tax does not apply to TFSA investments.

Be especially wary of selling investments to claim a capital loss, then buying it back to put in your TFSA. If you buy back an investment within 30 days, that’s considered a superficial loss, which will be denied (so you’ll have to pay the tax you tried to offset).

 

Can I use my TFSA as a trading account?

No. While you can sell investments from within your TFSA at any time for any reason, you should avoid using it to trade stocks like you would in a non-registered account. The Canadian Revenue Agency views active stock trading within a TFSA as “an adventure in the nature of trade” which would nullify the tax-free portion and cause the profits to be taxed as business income – not even capital gains!

The TFSA is not a trading account. It is an investing account. The main difference between investing and trading is time. Allow your investments to grow for a long time and you’ll face no issues with the CRA.

 

Can I gift a TFSA contribution to someone?

No. You can’t directly deposit money into someone’s account for them; however, you can gift them money which they can then move into a TFSA. Gifts in Canada are not taxed, so the recipient won’t have to declare anything on their taxes. There are no immediate tax benefits for you or the recipient, but the growth is tax-free.

 

Effects of investing in TFSA vs. Non-Registered

You can hold literally any type of investment in a TFSA, which allows for some really easy math to determine the effects of using your TFSA effectively. Let’s compare an example of two identical investors – TFSA Tom and Non-registered Nancy.

Both Tom and Nancy make $50,000 and are next-door neighbours in a downtown Toronto apartment building. Both of them buy the exact same ETF and make the exact same annual contribution. Let’s see how much more money Tom will have. Remember that capital gains tax is only paid when you sell the investment.

 

Beginning Investment

Annual Contribution

Years Invested

Interest Rate

Tax Paid on Sale

Final Value

Nancy

$57,500

$5,500

15

5%

$14,561.18

$223,659.29

Tom

$57,500

$5,500

15

5%

$0

$238,220.47

 

Tom comes out ahead by $14,561.18 just for putting the investment into his TFSA!

This is a very oversimplified equation. If the interest rate was higher, then Tom would come out even further ahead. If rates were lower, the difference would be smaller.

Investment Return

Capital Gains Tax Rate

How much more Tom would have

3%

14.825%

$7,690.79

4%

14.825%

$10,923.65

5%

14.825%

$14,561.18

6%

14.825%

$18,652.80

7%

14.825%

$23,253.60

 

The gap becomes even wider if they were in a higher tax bracket. Capital gains are taxed at half your marginal rate, which means that the higher your income the more tax you pay on capital gains. In the highest tax bracket in Canada (54%, Nova Scotia) here’s how much Tom would be ahead by:

Investment Return

Capital Gains Tax Rate

How much more Tom would have

3%

27%

$14,006.83

4%

27%

$19,894.68

5%

27%

$26,519.53

6%

27%

$33,971.38

7%

27%

$42,350.56

 

TFSAs and Retirement

As you can withdraw any amount from your TFSA at any time for any reason, there is no need to wait until retirement to use the money in your TFSA (unless you want to take advantage of compounding, which accelerates over time).

The best part about incorporating your TFSA into your retirement plans is that, since withdrawals aren’t taxed nor treated as income, they don’t affect your Old-Age Security (OAS) or Canada Pension Plan (CPP). Unlike an RRSP, which is considered income for tax purposes and results in OAS clawback, TFSA withdrawals have literally no effect on social benefits.

You can also continue to contribute to a TFSA even as you’re making withdrawals, so long as the contributions don’t go over the limit. There is no age limit to contributing to a TFSA.

 


TFSAs and Death

This is never fun to think about, but it is necessary. What happens to your TFSA after you die? Will it be victim to probate tax? Will it maintain its tax-free status?

That depends on if you assign a successor holder or beneficiary to the account, or if you do nothing.

A successor holder can only be your spouse or common-law partner and is given your entire TFSA tax-free, no questions asked. By naming a successor, you avoid probate because ownership is transferred as soon as you die without going into your estate. That person simply becomes the new holder of the funds from your TFSA. This also circumvents the TFSA contribution room requirements – they don’t have to have any available contribution room to inherit your TFSA, and if they did have available room it doesn’t count against them.

When a beneficiary inherits a TFSA, the amount that was within the TFSA is still contributed tax- and contribution-free, so long as they transfer the TFSA before December 31st of the year following your death. However, if the TFSA grew in value from the time of your death to the time of the transfer any extra amounts would be considered taxable income.

If you name neither a successor holder nor a beneficiary, but someone is still entitled to the estate, then probate fees would have to be paid, and any growth after the time of death would also be taxable.


Chris Chris 01/26/2019
Canadian personal finance buff and all-around writing enthusiast, Chris loves breaking down complicated money ideas to show that they're really not so complex. 
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