A couple of things frequently baffle investors about Tax-Free Savings Accounts (TFSAs). First, what are the contribution limits? And second, do you get a tax deduction or credit as you do with your RRSP contribution?
A Tax-Free Savings Account (TFSA) is a special federal government-registered account, introduced in 2009, that lets any investments held within it accumulate tax-free. In addition, withdrawals from the account are also completely tax-free.
Basically, you can contribute up to a maximum $5,000 to a TFSA for every year since it began in 2009, up to 2012. Starting in 2013, the government raised the annual limit to $5,500. In 2015, the Conservative government raised the limit to $10,000. However, that was repealed the next year by the incoming Liberal government, and the limit was reduced back to an annual $5,500.
What many people do not realize, though, is that the one-time $10,000 limit in 2015 still counts towards contribution room if you didn’t contribute in that year. So if you haven’t ever made any contributions to a TFSA, as of 2017, you have $52,000 in contribution room available. That’s $52,000 that you can invest right away, with absolutely no tax payable on any income or growth from that investment – ever!
The contribution limit is not income-tested, the way it is for an RRSP, so anyone can contribute the allowable annual maximum every year regardless of their income level. Unused “contribution room” can be carried forward and used in future years.
However, it is important to note that contributions are not tax deductible the way they are for RRSPs. In other words, you are investing after-tax income, but then again, there’s no tax payable at the back end.
One downside may be that like an RRSP and other registered plans, the tax benefits of certain kinds of investment income are lost within a TFSA. For example, the dividend tax credit is not available. And you do not have the ability to use tax losses to offset capital gains. You also lose the capital gains exemption inside a TFSA, but this is a moot point really, because any capital gains generated by investments in the account are completely tax-free anyway.
While you may withdraw funds from your TFSA at any time, you have to be careful you don’t contribute, withdraw, and recontribute in the same year. If you start using your TFSA like a straight deposit savings account, you may fall afoul of the penalties for overcontributing in a given year, and these can be pretty stiff. As a rule of thumb, treat your TFSA as a tax-sheltered savings vehicle, much like an RRSP, and not as a place to park cash for day-to-day expenditures.
Courtesy Fundata Canada Inc. © 2017. Robyn Thompson, CFP, CIM, FCSI, is president of Castlemark Wealth Management. This article is not intended as personalized advice. Securities mentioned are not guaranteed and carry risk of loss. No promise of performance is made or implied.