Tax-Free Savings Accounts are a great addition to the lineup of financial offerings provided by our government. First introduced in 2009, these accounts are easy to use with the money inside growing and being distributed tax free. What’s not to love?
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Setting Up The Tax-Free Savings Account
Setting these accounts up is simple. Anyone who is a Canadian resident, has reached the age of 18 and has a valid social insurance number can set one up at their local bank, insurance company, trust company or credit union. If you are a non-resident with a SIN, you can still set up a TFSA but there will be tax implications on any contributions made.
Selecting Different TFSA Types and Investments
Even though it’s called a savings account, it’s really more of a savings vehicle and can hold both saving and investment options. There are three different types of Tax-Free Savings Accounts you can set up including a deposit, annuity contract, or arrangement in trust. Investment options can include guaranteed investment certificates, mutual funds, bonds, some securities, and certain shares of small business corporations. It’s possible to acquire non-qualifying investments or prohibited investments inside a self-directed TFSA and is important to know that if either of these investments were to be acquired there will be tax implications.
Your financial advisor can help you determine which TFSA type and investment option is right for you. There may also be fees associated with the different types of accounts and it is best to ask your advisor what fees may apply.
Naming a Successor Holder and/or Beneficiary
When setting up your TFSA it’s also a good idea to consider naming a successor holder (where applicable) and/or a beneficiary. A successor holder will be your surviving spouse or common law partner who is designated as the successor holder and beneficiary designations may include your surviving spouse or common law partner, former spouse or common law partner, any children you may have, or even a qualified donee (I.e. registered charities and certain universities). These can also be named in your will or in the TFSA contract.
Where there is no successor holder or beneficiary named, the TFSA will flow through to your estate upon death where it will be taxed if necessary.
Contributions, Limits, and Carry Forward Room
After your account has been set up it’s time to start saving!
Every adult Canadian has been accumulating contribution room since the TFSA first started in 2009, regardless if you have opened a TFSA before or not or and even if you haven’t filed your income tax yet. There is a limit to how much can be contributed to your TFSA every year which is why, if you haven’t contributed before or you haven’t maximized your contributions, the accumulated contribution room going forward is so handy. Unfortunately for non-residents, you do not get to accumulate contribution room.
The annual contribution limit in 2020 is $6000. This limit (which may be different than your contribution room) has changed over the years and is used to calculate the contribution room for each individual. Any unused contribution amounts and withdrawals made in previous years are also used to calculate the total contribution room you may have. You can always view your contribution room information through the MyCRA mobile app.
Contributing to your TFSA is fairly straightforward. Any contributions made to the account are paid with after tax dollars and will not be tax deductible or receive tax credits. If you are one to borrow to invest then, unlike most loans for the same purposes, the interest on your loan will not be tax deductible when investing in your TFSA.
Now, typically there are exceptions to any basic rule and when it comes to the Tax-Free Savings Account, there are several ways of contributing funds that are not tax-free. It’s possible to overcontribute to the TFSA and if this were to ever happen, there will be a 1% tax applied to the contributions that are above the limit and for every month they remain inside the account. If you are a non-resident contributing to the TFSA, there will be a 1% tax applied to the full amount of your contributions and for every month they remain inside the account. If you are contributing funds from a non-registered account, you will need to include the withdrawn funds as income first and pay the tax accordingly before they are contributed. If you are contributing funds from a Registered Retirement Savings Plan, you will also need to include the withdrawn funds as income first and pay the tax accordingly before they are contributed.
It’s important to know that there are a several ways of contributing or distributing funds that do not affect your contribution room. Qualifying transfers, exempt contributions, and specified distributions are ways of doing this, though are only available in certain situations.
Using The Tax-Free Savings Account
As you start savings money inside your TFSA, any interest, dividends, or capital gains earned on investments will be credited to the account be tax-free. Losses inside investments are also possible and if this were to ever happen, the loss will not be considered a withdrawal or when calculating your contribution room for the following year.
Making Withdrawals and Transfers
Withdrawing the funds in your Tax-Free Savings Account can be done at anytime and for any reason with certain investment options (some investment options may be locked in). Any withdrawals are received tax-free and will create contribution room for the following year. If you’re planning to contribute more funds into the account the same year a withdrawal has been made, you will still be limited the contribution limit of that year because the new calculation will not have taken affect yet.
If you have more than one TFSA, you can transfer amounts between accounts with no tax consequences when transferred directly. Alternatively, if the funds were withdrawn from one account and then re-contributed to the second account instead of being directly transferred by your institution, there will be the 1% tax applied on contributions made over your contribution limit.
It’s important to know that withdrawing funds from your TFSA will not affect other government benefits you may be receiving that are based on income. Other government benefits include Old Age Security, Guaranteed Income Supplement, Employment Insurance, Canada Child Care Benefit, and the GST/HST credit.
Closing The Tax-Free Savings Account
Closing the Tax-Free Savings Account can happen when you withdraw the entire amount of funds inside the account and decide to close or upon death.
Closing Upon Death
Now upon death, the TFSA does not close automatically, and it will need to be determined if the account is to remain open or is closed, what the tax implications will be (if any), and what the beneficiary’s own actions will be going forward.
Determining the next steps in this situation depends on the type of TFSA (deposit, annuity contract, or arrangement in trust) held, if a successor holder or beneficiary was named, and how long the TFSA remained open after death and if there was any income earned during that time.
If there is a successor holder named, the surviving spouse or common law partner will become the new owner of the TFSA immediately upon death without any tax consequences. If the previous owner had any overcontributions inside their TFSA, these amounts will be considered as contributions in the new owners hands up to their contribution room limit. Where the contributions continue to be over the limit, the 1% tax will apply every month they remain in the account. As the new owner of the TFSA, the surviving spouse can choose to withdraw funds, contribute more funds up to their own annual limit, or transfer the funds directly into their own TFSA without tax consequences as a qualifying transfer.
If the TFSA is an arrangement in trust and there is no successor holder, the account will remain open as a non-taxable trust until the trust ceases to exist or for a full year after death, whichever is earlier. The funds can be paid out to beneficiaries during this exempt period where any earnings made before death will remain tax-free to the beneficiary and any earnings made after will be taxable. If the account is not closed and the trust continues beyond this year, it will become taxable going forward as an inter vivos trust.
If the TFSA is a deposit or annuity contract and there is no successor holder, the account will be closed. The deposit or annuity contract may remain open, however, with any earnings going forward being taxable to the beneficiary.
A beneficiary can receive the amount of funds inside the TFSA at the time of the owner’s death tax-free. They can choose to use the proceeds as contributions to their own TFSA up to their annual contribution room limit. When eligible, a surviving spouse who is a beneficiary can make an exempt contribution to their own TFSA without affecting their contribution limit.
If the beneficiary is a registered charity, Canadian municipality, registered Canadian amateur athletic association, United Nation and/or an agency of the UN, or university outside of Canada with Canadian students, the funds from the TFSA will be donated to the institution and a charitable donation tax credit can be claimed by the estate.
Key Features Desired By Most Canadians
Safety and Security:
- Predictable Results
- No Capital Loss
- Guaranteed Cash Accumulation
- No Capital Loss
- Guaranteed Cash Accumulation
Access to Money Without Penalty:
- Liquidity, Use and Control
- Guaranteed Loan Option
- Collateral Opportunity
- Free of Government Involvement
- Tax-Deferred Growth
- Tax-Free Distribution
- Tax-Free Death Benefit
- Tax-Deductible Contribution