I was talking with my Dad recently about money stuff (he’s a big investment nut as well) and he suggested writing about the TFSA again since it is going to be effective fairly shortly (Jan 1, 2009). A rather timely and excellent idea so here it is!
What is the TFSA?
A type of investment account where you make contributions but don’t get any tax refund. While the money is in the account there are no taxes applied to any kind of earnings such as interest, dividends, capitals gains. Any withdrawals from the account are not taxable and won’t count against any government programs ie GIS, OAS.
What are the TFSA rules?
- You can contribute $5000 per year to this account.
- The contribution room is carried forward.
- No taxes on any earnings.
- No taxes on any withdrawals.
- When you withdraw money from the account, the contribution room available gets increased by the amount of the withdrawal (ie you can put the money back in anytime without affecting the contribution room). Keep in mind that when you do a withdrawal, the new contribution room only gets added for the following year so you can’t keep withdrawing and contributing during the same year.
- You can transfer between financial institutions – this will work the same way as transferring your RRSP – there will be no effect on your contribution room.
- Similar to an RRSP, you can have multiple TFSA accounts.
- The TFSA annual limit will be indexed to inflation. However, it will only be increased in $500 intervals so the cumulative inflation number (over several years) has to be 10% before the limit will be increased to $5500.
When does it start?
You can set up a TFSA account starting Dec 1, 2008 and the first deposit can occur on Jan 1, 2009. There are a number of banks offering to ‘pre-enroll’ you in a TFSA or even ING which will give you a bonus to pay for your taxable interest for the remainder of the year. While there is nothing wrong with opening an account early, with the exception of the ING offer, there is no real benefit to you as well.
TFSA benefits
Any money that you might be saving for emergencies or upcoming large purchases will have a constant tax drag in an non-registered account. With the TFSA, this tax drag no longer exists so you will end up with more money for your purchase or emergency. This is the biggest benefit to the TFSA in my mind.
Another significant benefit is retirement planning – while the TFSA is not as good as the RRSP for most people, it is much better than a non-registered taxable account.
More information on the TFSA
Benefits of the Canadian tax free savings account
Tax Free Savings Account (TFSA) Basic information for Canadians
Comparison between Canadian TFSA and American Roth IRA
ING offers TFSA refresher for Canadians
Is the RRSP still worthwhile because of TFSA accounts?
Using the Tax Free Savings Account (TFSA) for Canadians as an emergency fund
{ 1 trackback }
{ 15 comments… read them below or add one }
The banks have been sending me lots of information on the TFSA. I only wish this kind of investment was available years ago.
It is overdue.
I’m debating on what instruments I am going to use, particularly at the outset. On the “safety and savings” hand, I am thinking of buying XCB – ishares corporate bond fund or a corporate bond mutual fund. XCB generally has outperformed bank mutual funds, the problem is that I’d be charged with a high commission of $19…thereby eroding two-months worth of interest if a held cash.
On the “shoot for the stars” hand: do you put all your money in one high risk, high reward miner/driller and hope for a double in order to maximize your contribution room ASAP? A homerun would significantly increase your contribution room: you could sell, keep $5000 in tax free play money and then move to safety. The downside of course is that your stock could crash, without the safety of a capital loss write-off.
Here are some unreported/underreported issues with the new TSFA…at least at the start with the $5000 max contribution level.
1) Fees and Commissions: most on-line brokers and banks charge an “administration fee” of $50-$100 for accounts under $5000. The “fee waiver level” for these accounts therefore wouldn’t occur until year 3: assuming you didn’t lose money on your investments. Which banks/brokers are going to try to sneak in these fees.
2) Trading commissions: I much rather buy an etf over a mutual fund in the same space. While many on-line brokers offer commission free purchases of mutual funds, I have shell out $19 to buy an etf…(double or triple if I want some diversification). In the first few years, trading commissions could quickly erode and savings benefits.
3) De-registration fees: If you want to de-register or partially dereigister an rrsp (to take advantage of the homebuyers plan) you have to shell out $75-$100. The TFSA are being sold as something you can easily take money in and out of when it is likely the banks will impose significant penalties for trying to move your money around.
fersure – good points about fees being charged on TFSA accounts. I would assume that whatever fees are being charge on open accounts would also apply to TFSA accounts.
As for $19 for trades? Don’t complain – just move to Questrade.
I already opened up this account at ING, but you say that you can have TFSA at multiple banks? Just so I understand, can each TFSA account have up to $5,000 in it and not be taxed? I’m a bit confused.
Alex – you have as many TFSA accounts as you want but your TOTAL contribution room each year is $5,000.
For example you can set up 5 TFSA accounts and contribute $1,000 to each account.
Question – I have already put $5000 in @ ING Direct but I also have an account at PC Financial. If I took out $600 from my ING account and put it into my PC what would happen at tax time? I really only put $5000 total but $600 of that was taken from my instution and moved to the other.
Mark if your PC account is a TFSA as well then you will be looking at a tax penalty.
The rule is $5,000 in gross contributions per year. If you have already contributed $5k and then withdraw $600, then that $600 only gets added to your contribution room in the following year.
What if I close my TFSA account of 5000 CAD & open a new TFTA account this year? Will I incur any tax penalty this year?
Saravana – yes you will pay 1% per month on the extra contributions.
Thanks for the info.
1) It’s hardly a month since TFSA came into existence. So hardly any interest would been accumulated for 1 month.So why will a penalty be incurred if the account is closed & new account is opened?
2) What if I transfer my TFSA account of Bank 1 to TFTA account of Bank2. Is this possible? Will I still incur a penalty?
Saravanan – I’ll answer in reverse order.
#2 – Yes, you can do a transfer of your TFSA from one institution to the other – in that case the transfer-out side will not count as a withdrawal and the transfer-in won’t count as a contribution. Be careful of transfer fees however – these will be charged by the “from” institution.
#1 – This rule is in place to prevent people from over-contributing to their TFSA at the beginning of the year and then withdrawing enough at the end of the year to get them within their contribution limit. Ie I could deposit $100k on Jan 2 and then withdraw $95k on Dec 31 – if you only counted contributions as the net of contributions and withdrawals – then I would have gotten tax sheltering for $95k for most of the year.
Thanks for the info. I think transfering existing TFSA to another institution seems to the best option. Yes will take care of transfer fees as well.
I appreciate your selfless service in enlightening people.Thanks once again.
Can I withdraw $10,000 which is already contributed in 2010, pay off mortgage by that $amount and then borrow to “replenish” the $10,000 to the TFSA. The rules say: to borrow to “contribute”…I’m technically NOT doing that! Thus borrowing to invest gives me that tax deduction and of course, the TFSA is tax free….WIN, WIN, WIN
is the moderator still watching this and answering questions??