TAX-FREE SAVINGS ACCOUNTS
TAX-FREE SAVINGS ACCOUNTS
Every taxpayer can contribute, cumulatively, up to $5,000 to a Tax-Free Savings Account (TFSA) for each year 2009-2012, $5,500 per year for 2013-2014 and 2016-2018, $10,000 for 2015 and $6,000 for 2019. Income earned on the funds in a TFSA is tax-free.
If you were at least 18 by 2009 when the TFSA began (i.e., you were born in 1991 or earlier), and you have been resident in Canada since 2009, then you now have a total of $63,500 in contribution room. It’s well worth it to have that money earning income in a TFSA where it is completely tax-free, even if you take the income out and spend it.
Each taxpayer has the same limit, so you and your spouse can each contribute the maximum.
TFSA contributions are not deductible for tax purposes, but income earned in the TFSA is tax-free and you can withdraw the funds at any time (subject to any restrictions on your investments — for example, if you have bought a two-year GIC, you might have to wait out the two years before you can access the funds, or pay a penalty to the bank for early withdrawal).
If you have investments that are earning interest or dividends that are subject to tax, make sure to max out your Tax-Free Savings Account.
A few TFSA tips and traps to be aware of:
• You can withdraw funds from your TFSA at any time, but you must wait until the next year to replace those funds, once you have hit the contribution limit. Otherwise the funds you replace will be subject to a 1% penalty tax per month.
Example: suppose you have already contributed the maximum amount by February 2019. In March 2019 you need some cash and withdraw $3,000. If you replace any of that $3,000 by recontributing to the TFSA later in 2019, you will be subject to the penalty tax. You have to wait until January 2020 to replace the $3,000. (Once January 2020 comes, you will also have additional contribution room of at least $6,000 for 2020.)
• The Income Tax Act provides “attribution rules” to prevent income splitting that can reduce tax. For example, if you give or lend money or property to your spouse, income earned from that money or property is generally “attributed” back to you and taxed in your hands rather than in your spouse’s hands. However, income earned in a TFSA is not subject to the attribution rules.
Example: you earn $150,000 per year, and your spouse has no income and no TFSA. If you give your spouse $10,000 and your spouse invests the funds in stocks that pay a 4% dividend, the resulting $400 of income will be taxed in your hands at your high marginal rate. But if you put $10,000 into your spouse’s TFSA and the TFSA buys the stocks, the $400 of income is tax-free. (Note however that the attribution rules will start to apply if your spouse takes the funds or stocks out of the TFSA and they continue to generate income.)
• If you are thinking of playing any games with your TFSA to generate inappropriate tax savings, think again. The TFSA rules are designed to catch such game-playing, and have been severely tightened in recent years. Swaps between TFSA and other accounts, deliberate overcontributions, investments in non-qualified investments (such as one’s own business) intended to generate huge tax-free dividends ... these and other “planning” schemes are caught and in most cases subject to a 100% tax, so that they will backfire. Don’t believe anyone who proposes to “help” you use your TFSA (or RRSP for that matter) to access tax-free funds, unless you have the scheme reviewed and approved by an expert tax lawyer or chartered accountant.