INVESTMENT INSIGHTS FROM OUR EXPERTS

Investment Facts: Tax-Free Savings Account (TFSA)

October 20, 2014

Investor Education Series Part 2

 

 

In 2008 the Government of Canada introduced a brand new personal savings vehicle; Tax Free Savings Account (TFSA) effective as of January 2, 2009. The TFSA is a registered, multi-purpose savings vehicle that allows Canadians to earn tax-free investment income on eligible investments. The TFSA supplements other registered savings plans for example Registered Retirement Savings Plans (RRSP) and Registered Education Savings Plans (RESP).

 

Benefits of a TFSA

  1. Investment income earned (i.e. interest, dividends and capital gains) is tax-free.

  2. Investments permitted in a TFSA include: cash, mutual funds, securities listed on a designated stock exchange, GIC’s, bonds and certain shares of small business corporations.

  3. Savings can be withdrawn at any time from your account and are tax-free.

  4. Unused TFSA contribution room is carried forward and accumulates in future years. The Federal Government will report your TFSA contribution room to you annually.

  5. Full amount of withdrawals can be replaced within your TFSA in future years. Please note: Re-contributing in the same year could result in an over-contribution amount that is subject to a penalty tax.

  6. Income earned within a TFSA or withdrawals from the TFSA do not impact eligibility for federal income-tested benefits and credits (i.e. Old Age Security, the Guaranteed Income Supplement, and the Canada Child Tax Benefit).

  7. Funds can be given to a spouse or common-law partner to invest in their TFSA.

  8. Individuals who are no longer eligible to contribute to an RRSP now have the option to build up savings in a tax sheltered account. 

  9. In most circumstances TFSA assets can be transferred to a spouse or common law partner upon death. If you designate your spouse/ common law partner as a “successor holder” you may allow them to assume your plan without affecting their own TFSA. You may also designate “beneficiaries” to receive the funds in your plan. However, the TFSA will be dissolved and any income earned after death of the holder is 100% taxable.

TFSA Contributions

  1. As of January 2, 2009, TFSA contribution room accumulates each year with the following conditions:

    • 18 years of age or older

    • Hold a valid Canadian social insurance number

    • A resident of Canada.

  2. TFSA contribution room will accumulate each year regardless if you do not file an income tax and benefit return or open a TFSA.

  3. Unlike an RRSP, contributions are not tax-deductible.

  4. The annual TFSA dollar limit for the years 2009, 2010, 2011 and 2012 was $ 5,000.

  5. The annual TFSA dollar limit for the years 2013 and 2014 is $ 5,500.

  6. Therefore individuals who were over 18 years of age in 2009 will have accumulated $ 31,000 of contribution room as of 2014.

  7. Investment income earned by, and market changes in the value of the TFSA will not impact TFSA contribution room for the current or future years.

 

Over Contributions within a TFSA

 

The Canadian Revenue Agency imposes a 1% per month tax for each month or partial month that the excess contribution remains in the account. The 1% tax will continue until:

  1. The entire excess amount is withdrawn; or

  2. For eligible individuals, the entire excess amount is absorbed by additions to their unused TFSA contribution room in the following years1.

To summarize, the main points to take away from a TFSA are the following:

  1. The TFSA is a registered, multi-purpose savings vehicle that allows Canadians to earn tax-free investment income on eligible investments. Individuals who were over 18 years of age in 2009 will have accumulated $ 31,000 of contribution room as of 2014.

  2. Unlike an RRSP, contributions within a TFSA are not tax-deductible. Also, savings can be withdrawn at any time from your account and are tax-free.

  3. The full amount of withdrawals can be replaced within your TFSA in future years. Re-contributing in the same year could result in an over-contribution amount that is subject to a penalty tax.

Example 1

 

In March 2009, 2010, and 2011 Josh contributed $5,000 to his TFSA, the full amount of his contribution room for each year. He did not make any other contributions and he did not withdraw any funds. His unused TFSA contribution room at the end of 2011 was zero.

 

His TFSA contribution room at the beginning of 2012 was $5,000 (his 2012 TFSA dollar limit).

On June 15, 2012, Josh made a contribution of $500. On October 26, 2012, he withdrew $4,000.

His unused TFSA contribution room at the end of 2012 was $4,500 ($5,000 - $500).

Josh makes the following calculation to determine his TFSA contribution room at the beginning of 2013:

 

Step 1: Calculate Unused TFSA contribution room at the end of 2012

TFSA contribution room at the beginning of 2012 ($5,000) − Contributions made in 2012 ($500) = Unused TFSA contribution room at the end of 2012 ($4,500)

 

Step 2: Calculate TFSA contribution room at the beginning of 2013

Unused TFSA contribution room at the beginning of 2012 ($4,500) + Total withdrawal made in 2012 ($4,000) + 2013 TFSA dollar limit ($5,500) = TFSA contribution room at the beginning of 2013 ($14,000).

 

 

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