TFSA - DOs and DON'Ts

Peter Katevatis - Nov 14, 2014
The Government of Canada started a new savings program with very little fanfare in 2009 called the Tax Free Savings Account (TFSA).  There has been talk recently on the radio about these accounts, but Canadian investors have been so inundated with go

The Government of Canada started a new savings program with very little fanfare in 2009 called the Tax Free Savings Account (TFSA).  There has been talk recently on the radio about these accounts, but Canadian investors have been so inundated with government acronyms: RRSP, RRIF, RESP, CRA, GST/HST that adding one more to the alphabet soup seems dizzying.  Needless to say, the TFSA has gotten lost in the shuffle.  The beauty of this account though, is that all Canadians can benefit from a TFSA account since there is very little downside.

 

TFSA Alphabet Soup

First the mechanics:

  • You start each year with a limit which doesn’t change for the calendar year. 
  • You can contribute cash or securities at current value up to that limit.  Then you invest in a manner that matches your objectives and suitability and the funds grow tax free. 
  • If you need the cash for any reason there is no penalty for withdrawing the funds.  Fabulous isn’t it?
  • In fact, if you withdraw any amount during the year, that amount is added to next year’s limit. 

Easy math – limit of $5500 in 2013

  • Contribute $5500
  • Withdraw $2000 for home repairs
  • In 2014 you have your new limit of $5500 PLUS the $2000 that you took out in 2013 totaling $7500

“What’s the catch?” you ask?  You can only contribute $5,000 per year (2009-2012) and $5,500 the past two years.  If you have not used your TFSA Contribution room yet your 2014 limit would be $31,000.  Also, there is no deduction on contributions like a Registered Retirement Savings Plan (RRSP).   

 

If you are a high income earner the RRSP is still the best place to invest.  The short term tax benefit greatly outweighs the long term future tax liability.  If you are a low-middle income earner and you expect your income to grow in the future, you might want to save your RRSP contributions for a future date.

 

There is often a debate over what style you should use to invest in your TFSA.  Should you put your safe high taxable holdings like fixed income & bonds in your TFSA?  Or should your put your high risk “swing for the fences” junior equities in your TFSA?  The answer is to do what is suitable for you.  If you are comfortable with risk, go ahead with the equities, but there is nothing worse than a tax-free loss in the TFSA.

 

DOs

  • Maximize your TFSA contribution (check your limit with CRA)
  • Invest in a style that makes you comfortable
  • Make your withdrawals late in the year if you have to

DON'Ts

  • Pay taxes in a cash or margin account when you have excess TFSA contribution room
  • Contribute shares you are up on (your contribution will crystallize a capital gain without actually making $)
  • Over-contribute – the penalties are massive

The RRSP has some negative attributes that makes it unsuitable for certain individuals.  The TFSA was designed to help all Canadians and will be a very effective tool to reduce income tax payable in the future.

 

There are many more nuances to the TFSA account and I would be happy to answer any questions you may have.