TFSA rules and regs
Making TFSAs work for you
You may have a tax refund coming. Or you might have excess cash saved up because you’ve spent less during Covid. Or you’ve received an inheritance. Don’t let that cash sit around! Consider contributing to a Tax-Free Savings Account. Here’s what you need to know.
The annual contribution limit for Tax-Free Savings Accounts (TFSA) is $6,000 for 2021, unchanged from 2020. That means total contribution room available since the introduction of the plan in 2009 is now $75,500 for someone who has never contributed to a TFSA.
Rules and regs
You can contribute up to the maximum $6,000 annually, working or retired, regardless of income, pension plans, or anything else, anytime during the year. You may also top up your contribution if you have any contribution room left over from previous years when you did not contribute. You simply have to be over 18 and a have a valid Canadian Social Insurance Number.
There’s no tax deduction for contributions as there is with a Registered Retirement Savings Plan (RRSP), but investment income generated within the plan – whether interest, dividends, or capital gains – is completely tax-free. And as with RRSPs, you lose the benefits of the dividend tax credit, the capital gains exemption, and the use of capital losses within the TFSA. And all withdrawals are tax free.
Like any registered pension or retirement savings plan, the rules and regulations can get complicated. Only “qualified” investments are eligible for TFSAs. Fortunately, that’s very much like those allowed for RRSPs: cash, stocks listed on designated exchanges, mutual funds and ETFs, bonds, GICs, and certain shares of small business corporations. Shares traded “over-the-counter” on dealer networks or exchanges are not qualified TFSA investments.
“In kind” contributions of qualified investments are also allowed (for example, stocks transferred from a non-registered account) in your TFSA. But any in-kind transfer will trigger a deemed disposition of the security at its fair market value when you transfer it from its source (e.g., an RRSP), which will be considered as the amount of your contribution. If there’s a capital gain, you will have to take 50% of that gain into income for tax purposes. But if there’s a loss on the disposition, you cannot use it to offset other gains.
If you overcontribute (for example, by losing track of what you’ve taken out and put into your TFSA during the year), the CRA levies a tax penalty of 1% per month based on the highest excess TFSA amount in your account for each month in which an excess exists. This means that the 1% tax applies for a particular month even if an excess amount was contributed and withdrawn later during the same month. The excess-amount tax kicks in on the first dollar of excess contributions.
If you’re a high net worth investor and your tax situation is more complicated than normal, or your investment strategy involves anything beyond simple asset allocations, consult with your financial advisor to ensure you make the most of your TFSA and avoid tax penalties.
As for estate planning, there are a couple of things to keep in mind. It boils down to whether you want the TFSA to go to specific individuals when you die or simply to be folded in as part of your estate to be distributed according to the provisions of your will.
The CRA recognizes two types of beneficiaries for TFSAs. First, is the successor holder designation by which the rights of the TFSA are conferred on the surviving spouse or common-law partner. Then, there’s the “designated beneficiary” (this could be a survivor who has not been named as a successor holder, former spouses or common-law partners, children, and qualified donees, such as registered charities) by which they will not have to pay tax on TFSA withdrawals, as long as the total payments don’t exceed the fair market value of all the property held in the TFSA at the time of the holder’s death
Note that the type of beneficiary can be affected by other designations made for the TFSA, provisions made in a valid will, and the succession legislation applicable in the province where the TFSA holder lives.
This is by no means a complete explanation of all the twists and turns that can occur with TFSAs (or other registered plans, like RRSPs) when considering estate planning implications. Your best course of action is to consult with a qualified financial planner or your lawyer to ensure you get the estate planning outcome you want.
Robyn Thompson, CFP, CIM, FCSI, is the founder of Castlemark Wealth Management, a boutique financial advisory firm specializing in wealth management for high net worth individuals and families. Contact her directly by phone at 416-828-7159, or by email at firstname.lastname@example.org for a confidential planning consultation.
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