10 Things You Need To Know About Tax Free Savings Accounts (TFSA’s)
1. How does a TFSA work? The TFSA was launched in January, 2009 and can be defined by what it is not. Unlike a Registered Retirement Savings Plan (RRSP), the contributions to a TFSA account are not tax-deductible. Your contributions to a TFSA account are made with after-tax cash but you can withdraw it tax free. Making a contribution to an RRSP account gives you a tax deduction, but when you take money out of an RRSP you pay tax on the amount you withdraw. The tax free savings account, as the name suggests, is a tax free savings haven rather than a tax-deferred shelter like an RRSP.
2. Forever tax free You never pay tax on the money inside your tax free savings account, so you can invest in many different investments solutions. You cannot deduct the interest if you borrow money to invest in your tax free savings account, but the other benefits are attractive. When you take it out, it’s still tax free and it won’t affect your eligibility for income support programs based on earning levels.
3. What investments can be held in a TFSA account? Generally the investments that can be held in a tax free savings account are similar to those of other plans and include everything from GICs to mortgages. In addition to making cash deposits to buy investments, you can make in-kind contributions by transferring shares and mutual funds that you already own into your TFSA account. The rule is that the investment must be arm’s length from you (for example, personal debt is not allowed) You must open a TFSA account through a financial institution, but if you wish you can make it a self-directed account and manage it yourself, or have a firm which is registered as a Portfolio Manager manage it for you.
4. Beware of over contributing. You are allowed to contribute $10,000 for 2015 and carry forward the unused portion to the next year. But be careful. Many Canadians have been confused by the rules and face penalties as a result. For example, if an account holder withdrew money from their TFSA account in January and then put the amount back into the TFSA in June of the same year the individual would be shocked to discover that the redeposit was considered a double payment and subject to a hefty tax penalty.
5. Save and save some more If you need spending money, go ahead and dip in. The funds you take out give you equal contribution room the next year. So if you remove $3,000 for a vacation this year, you can contribute that same amount (in addition to the $10,000 maximum) the following year for tax free savings. Just be careful not to reinvest during the same calendar year.
6. Contributions carried forward You can take advantage of your unused contribution room at any time in your life. You may be one of those people who starts saving early (you have to be over 18 years old to open a TFSA), even when you don’t have an income that allows you to save the maximum annual amount. With a tax free savings account you can be rewarded for procrastinating by catching up on the contributions later on. There is no upper age limit for TFSA contributions either, unlike RRSPs that require you to stop contributing to the fund at age 71.
7. Give a TSFA contribution as a gift to your spouse Go ahead and surprise him or her by giving a cash gift for them to contribute to their TFSA account. You don’t receive any tax benefit from this but it doesn’t affect your personal contribution maximum either. And hey, it lasts longer than flowers. Also, your spouse can be the beneficiary of your plan after your death. But it is important to ensure your spouse is named the survivor holder on the beneficiary designation when you are opening a TFSA account. This will ensure that at your death your TFSA account can be rolled over to your spouse’s TFSA account without tax consequences, even if your spouse has no remaining contribution room available in their own TFSA account.
8. Compounding power Investment advisors love the charts that illustrate that by putting away a few dollars each month for a lifetime, you could be rolling in dough, unlike your colleagues who spent it on lattes. So start early with tax free savings - being disciplined has its advantages.
9. Canadian residents only Non-residents of Canada are not eligible to open a TFSA account. If you happen to leave Canada after you have opened a tax free savings account, you can maintain your existing TFSA, but you cannot make any further contributions to it while you are a non-resident.
10. Low risk strategy Since you cannot claim capital losses in your TFSA on investments that have lost value, it may best to consider investments that provide capital preservation along with moderate growth in your TFSA account. Also, because the maximum annual contribution is not high enough to spread your market exposure around, it makes sense to choose investments such as exchange-traded funds that represent a broad sample of securities or some of the soon to be available Alternative Access Funds from Northland Wealth which hold a diversified selection of leading alternative asset managers and strategies – the very same used by major Canadian pension funds.