What is a Tax Free Savings Account?

Aaron Arnold, Investment Advisor, BA (Econ)                                                                         August 30, 2013

Tax Free Savings Accounts have been around since 2009 but yet I constantly get questions about them. What is a TFSA? How much can I contribute? What are eligible investments? Please see below for answers to 12 common TFSA questions.

1) What is a TFSA?

As of January 1, 2009, the federal government is providing a new tax efficient savings account for Canadians, the TFSA or Tax-Free Savings Account. This account will allow the holder to contribute up to $5,500 into the account and invest in a wide range of investments. Although there is no tax deduction allowed on the contributions, the income earned in the account is tax free and any withdrawals will also be tax free.

2) Who can open a TFSA?

Canadian residents 18 or older with a SIN can open a TFSA. However, inBritish Columbiathe age of majority is 19 so individuals will have to wait until they are 19 to open a TFSA in BC. Individuals in BC will accumulate TFSA contribution room for the year they are 18 and can carry that forward.

Example:

Sophia turned 18 on February 18th 2013. She will not be able to open a TFSA until February 18th 2014 but she will be able to contribute $5500 for 2013 and another $5500 for 2014 to max out her account at $11,000.

3) Is there a maximum age to hold a TFSA?

Unlike the situation with an RRSP, there is no maximum age to hold a TFSA. This makes this account particularly attractive for people older than 71 who are seeking tax efficiency.

4) How much can be contributed to a TFSA?

Up to $5,500 can be contributed to a TFSA annually as of 2013. This is a collective maximum so if multiple TFSAs are held the total amount contributed cannot exceed $5,500. This amount will be indexed to inflation annually and should therefore be increasing over time.

From 2009 to 2012 the maximum was $5000 per year. The total maximum contribution is currently $25,500.

5) Is there carry forward for TFSA contributions?

Unused TFSA contribution room can be carried forward to subsequent years. For example:

Ty Law contributed $3,200 to a TFSA in 2012. In 2013 he can contribute up to $7,300 to a TFSA or TFSAs, $5,500 arising in 2013 plus the $1,800 unused in 2012 ($5,000 – $3,200).

6) Will withdrawals from a TFSA affect the amount of contribution room?

Unlike RRSPs, withdrawals from a TFSA create additional contribution room. For example:

Dawn French contributed $4,000 to a TFSA in 2009. In 2010 she contributed an additional $3,000 and withdrew $2,000. Her contribution room in 2011 will be:

New room arising in 2011            = $5,000

Carry forward from 2009 = $1,000 ($5,000 – $4,000)

Carry forward from 2010  = $2,000 ($5,000 – $3,000)

Addition of withdrawal in 2011     = $2,000 (She can replace the amount she withdrew in 2010)

New contribution room in 2011    = $10,000

7) What are eligible investments for a TFSA?

Eligible investments for a TFSA are essentially the same as for an RRSP which provides excellent flexibility.

8) What are not eligible investments for a TFSA?

Investments specifically ineligible in a TFSA are:

i.  loans to the TFSA holder

ii. shares or debt of a corporation, partnership or trust in which the TFSA holder or his/her non arms-length associates have a significant interest (generally 10% or more)

9) What happens to the TFSA upon the death of the owner?

If a spouse is named as the sole successor on the account there are no tax implications on death and that person assumes the account. If there is no spouse the account will maintain its tax-exempt growth status until the earliest of:

i. the end of the year following the year of death, and

ii. the date the TFSA ceases to exist

10) Is it better to invest in a TFSA or a RRSP?

This depends on individual circumstances such as tax rates and liquidity needs. However, in general, if you are in a low tax bracket and earn under $43,562 a year or you have maxed your RRSP you should contribute to a TFSA. If you are in a high tax bracket earning over $43,562 and your retirement tax bracket will be lower than your current tax bracket you should contribute into a RRSP.

11) Will TFSA withdrawals represent income for government benefits?

Certain government benefits are income tested and those benefits will be reduced and eventually eliminated when net income from other sources exceeds certain limits. Examples of these ‘income tested’ benefits are OAS, Employment Insurance, the Canada Child Tax Benefit and the GST tax credit. Withdrawals from a TFSA will not constitute income for the purposes of those claw backs and may therefore be more beneficial than RRSP/RRIF withdrawals.

Example:

In 2012 Jules Lefebvre, age 70 needs $85,000 to support himself. He has RRSPs and a TFSA. The OAS claw back limit for 2012 is $69,562. If he withdrew $85,000 from his RRSP he would be subject to a claw back of his OAS benefits of 15% or $2,316 (($85,000 – $69,562) × 15%). On the other hand, if he withdrew $69,562 from his RRSP and took the additional $15,438 from his TFSA he would not be subject to any claw back of his OAS benefits.

12) What happens to TFSA investments upon marital breakdown?

Generally, when there is a marital breakdown any TFSAs held become marital property and depending on the separation agreement can be transferred to the TFSA of the recipient spouse tax free without affecting the TFSA contribution room of either party.

If you have any further TFSA questions or if you want to start taking advantage of tax FREE investing please feel free to contact us.