Tax-Free Savings Account

Introduction

The Tax-Free Savings Account (TFSA) was introduced in the 2008 Federal Budget and accounts could be opened starting on January 1, 2009. No tax is levied on income or gains inside these accounts. There is no tax deduction available for amounts contributed to a TFSA.

TFSAs are available to residents 18 years and older who have a valid Canadian social insurance number. The initial maximum contribution limit when the program was introduced was $5000 a year; this amount is indexed to inflation in $500 increments (see Contribution limits below). No prohibitions on income-splitting apply, so spouses can contribute to their partner's TFSA without eating into their own contribution room, unlike spousal RRSP contributions. And, unlike non-registered accounts, or withdrawals from an RRSP, investment earnings are not attributable to the spouse who supplied the funds.

Withdrawals are permitted at any time; the amount that is cashed out can be recontributed in the following calendar year. That means, effectively, that growth on the original investment counts toward recontribution room. For example, if the TFSA account is worth $5200 after the first year and the investor withdraws $5100, that $5100 can be recontributed later.

Unused contribution room, as for RRSPs, can be carried forward indefinitely.

Unlike an RRSP or an RRIF, there is no terminal date for a TFSA before death. At death, TFSA earnings cease to be tax-exempt; there are special rules for spousal transfers.

Non-residents can maintain their TFSAs, but no new contribution room is accumulated.

Many investors wonder whether a TFSA (no tax deduction for contributions but withdrawals go untaxed) or regular RRSP (which gives a tax refund on contribution but taxes withdrawals fully) is the best choice. See TFSAs versus RRSPs.

Contribution limits

The TFSA dollar limit is indexed based on the inflation rate. The indexed amount will be rounded to the nearest $500.

Year	Contribution Limit	CPI	Indexed Amount
2009	$5000	N/A	$5000
2010	$5000	1.4%	$5000 x (1 + 0.014) = $5070
2011	$5000	0.6%	$5070 * (1 + 0.006) = $5100
2012	$5000	2.8%	$5100 * (1 + 0.028) = $5243

Questions and Answers from CRA

1. What is the Tax-Free Savings Account (TFSA)?
2. Who can open a TFSA?
3. How do I open a TFSA?
4. I turn 18 in May 2009. Can I contribute to a TFSA in January 2009?
5. How much can I contribute to a TFSA?
6. If I don't make the maximum contribution to a TFSA this year what will happen to the room I don't use?
7. How will I know what my contribution room is?
8. How do I accumulate TFSA contribution room?
9. How is a TFSA different from an RRSP?
10. Can I transfer money directly from my RRSP account to a TFSA account?
11. Can I have more than one TFSA account?
12. What happens if I overcontribute to a TFSA during the year?
13. I am presently unemployed. Can I still open a TFSA?
14. Are there any restrictions on withdrawals from a TFSA?
15. Are withdrawals from a TFSA subject to income tax?
16. Will any withdrawals from my TFSA affect my Old Age Pension (OAS), Guaranteed Income Supplement (GIS) or any other federal credits?
17. Can I contribute foreign funds to a TFSA?
18. What kind of investments can I hold in my TFSA?
19. Can I contribute to a TFSA if I don't file a tax return?
20. Can I give my spouse or common-law partner money for their TFSA?
21. If I am a Canadian citizen but considered to be a non-resident for income tax purposes, can I still contribute to a TFSA?
22. If I become a non-resident during the year, am I still entitled to contribute to a TFSA?
23. What happens to my TFSA when I die?
24. When I die, will my TFSA be transferred to my spouse or common-law partner?
25. What happens to my TFSA if I die and I do not have a spouse or common-law partner?

Overcontributions

As indicated above in What happens if I overcontribute to a TFSA during the year?: If, at any time in a calendar month, there is an excess TFSA amount in your account, you will be subject to a tax of 1% per month on the highest excess amount, for each month that the excess remains in the account.

As of October 20, 2009, that changed: Finance said that “some TFSA holders are attempting to generate a rate of return” by going over the limit for “a short period of time,” in the belief they can earn more than enough to outweigh the cost of the penalty. To close the loophole, Finance instructed the Canada Revenue Agency to charge a levy of 100 per cent on overcontributions.

Additionally, one should be aware of how overcontribution is defined. Withdrawals during the year that are subsequently re-deposited during the year are considered a new contribution. For example, if you contribute $5000 on January 1, withdraw it on January 2, and re-contribute it on January 3, you will be deemed by Revenue Canada to have contributed $10,000 for the tax year. You will be charged a penalty of 1% of the overcontributed amount times the number of months that it was overcontributed - 1% x $5,000 x 12 = 1% x $60000 = $600. None of the examples given clearly show this situation.

Carrick has suggested that CRA may be willing to provide relief from the penalties if an honest mistake was made. The appropriate form is RC4288 Request for Taxpayer Relief.

US withholding taxes

Although US-based ETFs or stocks can be placed within a TFSA, US taxes will be withheld on distributions. Unfortunately, no Canadian tax credit can be claimed for these taxes. Therefore, US-based stocks and ETFs should generally be placed outside a TFSA.

Offerings

Brokerages

• Canadian ShareOwner Investments
• National Bank Direct Brokerage
• TD Waterhouse
• CIBC Investor's Edge
• BMO InvestorLine
• RBC Direct Investing
• ScotiaMcLeod Direct Investing

Banks

• Canadian Tire Financial Services
• BMO Financial
• Dundee Bank of Canada
• ING Direct
• National Bank of Canada
• President's Choice Financial
• RBC Royal Bank
• Scotiabank
• TD Canada Trust
• CIBC

Comparisons

Fees for RRSPs and TFSAs from various suppliers have been compared by Rob Carrick.

Current comparisons are available at RedFlagDeals.com

When comparing institutions, check very carefully. Start first with your objectives. For example, if you wish to use a pre-authorized purchase plan(PPP) to invest $25/month into TD Monthly Income, you will not be able to use RBC because RBC only offers a $25 PPP on RBC funds. And the product offered by a brokerage may not have the same fee structure as that of the same institution's bank. For example, although both allow one free withdrawal per month, TDWaterhouse charges $25/withdrawal thereafter while TD Canada Trust charges $5/withdrawal thereafter.

External links

• Canada Revenue Agency, Tax-Free Savings Account (TFSA) for Individuals
• Canada Revenue Agency, RC4466 Tax-Free Savings Account (TFSA), Guide for Individuals