Have you wanted to invest in a tax free savings account (TFSA) but are unclear on the rules? We’re going to talk about the basics of TFSAs so that you can you can effectively use your contribution room.
1. TFSAs were introduced in January 2009, where each person was allotted $5,000 of contribution room per year. This means that as of 2012, you have $20,000 of room in total if you have never set up a TFSA (the annual limit will be indexed in the future). TFSAs can be used to contain many different types of investments, including GICs, savings accounts, stocks, bonds and mutual funds. You can set up multiple accounts and contribute as many times as you like throughout the year (within your contribution limit). Unlike an RRSP, you do not get a deduction on your taxes when you make a contribution to a TFSA. However, also unlike an RRSP, withdrawals, including any income earned on the investment (interest, dividends, capital gains), are not taxed.
2. When you make a withdrawal from a TFSA, you do not get to re-contribute that amount until the following year. For example, let’s say you have the full $20,000 invested in various TFSAs as of today. If you decide to withdraw say $3,000 this year, you cannot re-contribute that $3,000 until January 2013. As well, any income that you have earned on your investments that is withdrawn forms a part of your contribution room available at the start of January the year following. For example, if you have contributed $5,000 to a TFSA mutual fund account and you sell and withdraw it for $5,300 in 2012, you now have $5,300 of additional contribution room beginning in 2013. Put simply, your contribution room each year consists of your annual limit of $5,000, your unused contribution room from previous years, and the total amount of withdrawals you have made in previous years.
3. While TFSAs can be a good tool for saving money for the short term where you need quick and reliable access to the funds, in which case a high-interest savings account may be a good option, they are also very attractive for holding investments where the potential for gain is larger, such as with equities. When looking at what investments will be the best fit for your TFSA given your financial goals, one point to keep in mind is that capital losses incurred within a TFSA cannot be used to offset capital gains that you may have in a non-registered account.
4. TFSAs can be transferred between financial institutions. You can transfer the funds from one TFSA to another TFSA without affecting your contribution room, but it must be a direct transfer and completed by your financial institution. If you withdraw funds from one TFSA and then try to re-contribute to another, your contribution room will be affected.
5. If your contributions exceed your TFSA room at any time, you will be subject to a 1% penalty tax per month on the highest amount of excess present in each month until the excess funds are withdrawn, or the new room that you accumulate each year nets against your excess.
Article by Stephanie Ham