TFSA Basics

We are currently in the 6th year since the new Tax Free Savings Accounts (TFSA’s) originated. Since that time, we have seen some errors made and have fielded certain questions pertaining to this new tax concept. The following is intended to give a better understanding of how TFSA’s work and what are some mistakes that  are made when setting them up and when making contributions.

History and Concept of TFSA’s (simple version):

TFSA’s started in 2009, entitling Canadian citizens over the age of 18 to purchase a maximum of $5,000/year. This amount will accumulate each year and was then subsequently increased to $5,500 for 2013 and 2014, creating a current total of unused TFSA contribution amount of $31,000 ($5,000 for the 4 years from 2009 to 2012 plus $5,500 for 2013 and 2014).

Advantages: TFSA’s, as the name applies, allow for tax free growth to occur inside the plan and also for tax free withdrawals to be taken from the plan at anytime. A TFSA will allow for interest, dividends or capital gains to be generated tax free inside the plan. A secondary advantage of a TFSA is the option of naming a beneficiary on the plan, this will assist in simplifying estate planning issues and saving probate costs in an estate situation.

Disadvantages: Unlike an RRSP, a TFSA “Does Not Allow” for a tax deduction to occur on the deposit. TFSA’s are funded with after tax capital.

RRSP vs TFSA??: We have been asked on several occasions which is better. The simple answer (everyone situation is unique) is based on a person’s marginal tax rate at the time of purchase and expected tax rate at the time of withdrawal. As the future tax rates may be somewhat hard to determine the general rule of thumb is:

  1. If you don’t expect your current tax rate to be that much different from the rate of tax you may be paying in retirement (ie. when you withdraw your RRSP) then the RRSP vs the TFSA is the same. Basically if the same investment is used, and the tax rate for the RRSP will be the same when you purchase it and the same when the money is withdrawn then there is no ultimate difference between an RRSP and TFSA from a “Net Tax” perspective.
  2. Alternatively, if it is expected that your tax rate will drop when you retire or when the RRSP is withdrawn, then the RRSP becomes the better tax vehicle over the TFSA.

The above is the basic simplified analysis. Other possibilities, like using a TFSA as an emergency reserve vs an RRSP etc.,  create  a different conversation applicable to each individual’s situation.

Warnings!!!  The most common mistake being made with TFSA’s is regarding Over Contributions!! This can happen in two ways:

  • Client does contributions and withdrawals in the same year. If a person has contributed his/her maximum amount to a TFSA and withdraws funds from the TFSA, they need to wait until January of the following year to make another contribution or put back the funds that they have withdrawn.

Important to also know that the funds withdrawn from the TFSA (including gains) can be put back into the plan.
see example below:

  • The other common mistake is clients who have more than one TFSA and mistakes being made with over contributions. Many of the banks are trying to convince people to purchase TFSA’s and in some cases people have forgotten that they have already setup a TFSA and made maximum contributions with their planner. An over-contribution  can generate  several problems with penalties and paperwork to unwind.

Example: up to 2014, Susan has contributed the full amount of $31,000 to her TFSA account. As of January 1st 2014, her balance inside her TFSA totals $34,500 which is her original $31,000 plus a gain of $3,500. Susan decides on Jan 15th  to pull out the full amount to purchase a car. As a

nice surprise, her father decides to pass down part of his estate early to his 3 children, Susan being one of them. She receives $50,000 from him as a gift and takes $34,500 and puts it back in her TFSA.

**Please note that Susan is not allowed to do this as her limit to purchase extra TFSA amounts  is currently set at $0 in 2014 and will not be readjusted until January 1st 2015. As a result, Susan would have to pay an “Over-Contribution” penalty on the $34,500 that she contributed back into the plan, from the date she added the funds back till Dec. 31, 2014. Not only is the penalty quite severe, but the paperwork to withdraw the funds is equally severe.

**In the above example, it is important to realize that on Jan 1st 2015, Susan would be able to re-contribute the $34,500 amount (which includes her original TFSA capital balance of $31,000, plus her gain amount of $3,500 that was withdrawn. On top of this, she would also be able to add another $5,500 for her new contribution amount in 2015, bringing her contribution total in 2015 to $40,000 ($34,500 + $5,500).

So knowing your TFSA limit is quite important and its best to only have one plan so that tracking contributions and withdrawals is easier.

The following are instructions on how to contact the Canadian Revenue Agency to find out what your TFSA limit is.

To ensure we have your current contribution limits correct, it would be most helpful if you could provide us with copies of your CRA TFSA summaries (which can be accessed through CRA’s ‘My Account’: Alternatively, you can confirm your available room by calling the CRA using the following instructions:

To confirm TFSA contribution room up to the previous year-end:

CRA#     1-800-267-6999
Press 1 for English
Press 6 for TFSA information
Press 2 for Contribution Limit

When calling he will need the following information:

SIN number
Month and Year of birth
Amount of income from line 150 of your previous year’s tax return (not the number from your Notice of Assessment)

This is important for us to have the correct information to ensure over-contributions are not made, which result in significant charges by the CRA.

If you have any additional questions or would like to make a TFSA contribution, please contact our office at your convenience.

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I used to have a dog named TAX , whenever I opened the door, Income TAX .

Just a reminder…it’s that time of year!!!!! Purchasing RRSP’s closes the door on this doggone tax problem.

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Effective October 1st, 2014
Unit 2-15 Cadillac Ave
Victoria BC V8Z 1T3
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