Tax Free Savings Account Info For Canadians
So I’ve completed some of my Tax Free Savings Account (TFSA) homework and already I’m impressed. If you don’t already have one set up, hopefully by the time you finish reading you will understand you need to get an account established. Just to warn you, if you haven’t already set one up, it’s not a race, you actually should do some of your own research first as there are many options. As always, some options are much better than others are.
To start with, many people are wondering exactly what is a TFSA and how does it work? When I started researching, I was expecting a very complicated answer to this question, but as it turns out, it’s surprisingly simple. It also has some very promising long term implications as a savings/investment tool.
A TFSA is a special savings account that can be opened by anyone who is a resident of Canada 18 years of age or older. This savings account has a current contribution limit of $5,000 per year and any growth in the principal is completely tax free. This $5,000 is indexed to inflation, but will never decrease below $5,000, so over time you will be able to contribute more in some years and potentially this limit will increase each year.
The part that gets interesting is you can hold the same types of investments in your TFSA that you would also be able to hold in an RRSP. Traditionally this would be mutual funds, GIC’s, bonds and publicly traded securities. Many people are unaware that they can also hold Arms Length mortgages, Mortgage Investment Corporations (MIC’s), or other real estate secured financial instruments in RRSP’s as well which can also be held in a TFSA.
While mutual funds and securities can be quite volatile as everyone has seen with the stock market lately, GIC’s and bonds however are quite stable with their returns. The problems with GIC and bonds are there is so little risk that the returns are low single digit and after inflation you end up almost breaking even, which is not how you get ahead with an investment.
Opportunities like MIC’s and Arms Length mortgages however tend to be slightly riskier, but are attached to property which I consider very secure, and tend to have fixed yearly returns of high single digit and low double digit. Coupling products like these with compounding interest inside a TFSA creates an opportunity for individuals to generate significant growth over time all tax free.
If you consider a couple each investing $5,000 per year in their TFSA and generating a 10% per year return after ten years the $100,000 invested by the couple would be worth $175,000 and is all tax free. Now if you compare this same situation to a $5000 yearly contribution to an RRSP, with the same yearly growth, you would also have the same amount of money at the end, but when you are forced to withdraw it from your RRSP, you would then be taxed on the entire amount!
I’m not positioning this as the end of RRSPs, but as a complementary tool to utilize if you currently have RRSP’s. Or if you don’t use RRSP’s to take advantage of the deduction, you can use the TFSA to save future taxes.
Some great options you have with the TFSA that really help seal the deal is the ability to withdraw from the account at any time and then re-contribute this withdrawn amount back in future years. This allows a younger person just starting out to potentially use the TFSA to save money for a down payment on a house tax free. Or a family could use it as an emergency fund that grows tax free.
Another appealing aspect is carrying over any unused contribution room. If you only have $1,000 to add to it next year, you could then add $9,000 in the following year. This will negate much of the value of compound growth, but will also allow you to contribute more in profitable years, and less in slower years, without being penalized.
Now as you are probably aware, every bank and trust company you can find in Canada seems to be offering to set you up with an account. The part you need to be aware of is that the majority of these institutions will only allow you to place these funds into the limited financial instruments like GIC’s, mutual funds and bonds that they offer. If your goal is to put a certain security fund or MIC into your TFSA, you better be sure you are allowed to do that through the institution you are working with.
Much like RRSP’s there are also some companies allowing you to set up self directed TFSA’s, but if you establish your account with one bank, you may incur additional costs transferring it over to another place. This will require you to have a plan prior to randomly starting the account at your closest bank.
I hope you can see some of the positive possibilities available through setting up one of these accounts and I have managed to get you a bit excited about this. I’m currently looking into more information about some of the MIC’s as I think this may be one of the better options to get started with for people. They are have slightly more risk than a GIC, significantly less risk than most mutual funds, and provide a pretty stable return to grow your investment.
So I have now walked you through the basics of Tax Free Savings Accounts, I’m sure I have now opened a new topic with the option of MIC’s and many of you may be wondering how and where to get information on these. Well don’t worry I won’t leave you hanging with this either. I’m working on information on this as well, so if you want to get updated on this make sure you leave me a comment, email me or give me a call.
Bill Biko http://www.investors.housez.ca
Helping People Generate Their Own Wealth. Visit our blog to find out more!
Tax Free Savings Account FAQ:
Question: What is a tax-free savings account in Canada?
I saw an ad at my bank about opening up a tax-free savings account. That surprised me, because how is the government supposed to know how much you have in your bank account? I never saw that anywhere on the tax forms. I thought the government only taxed you based on how much you make per year. What does a tax-free account mean and should I get one?
Answer: If you have a bank account and earn interest on your money, that interest is taxable. So if you have a lot of money in the account and make, let’s say $200 in interest, that $200 is taxable. The government will know how much you made in interest because the Bank will tell them and issue you (and the Gov’t) a tax form indicating how much money you made in that account.
A Tax Free Savings account is one where the money you earn on your savings (the interest) is NOT taxed; you get to keep it all. You will likely have a maximum of $5000 that you can put into such an account each year (which is more than most people need) and all the interest grows without being taxed. The bank will register that account with the government so they know there will be no tax owing on the interest you make. It was established to help encourage people to save for retirement.
Question: I have vested Restricted Stock Units. Is it smart to transfer them (in kind) to a tax free savings account?
I’ll probably sell them in 3 years or so and I expect that they will increase in value.
Answer: If you transfer any property into a TFSA, you will be deemed to have sold them at whatever their fair market value is on the date of transfer. In the case of stock, this would normally result in you having to report a capital gain. You would not be able to claim a loss as the TFSA would be considered an affiliated person, and the transaction would fall under the superficial loss rules.
Is it smart? Well, essentially, you would be stopping any taxes that will accrue on gains after the transfer. In addition, you would no longer be taxed on any dividends that are paid from the stock as these amounts would be paid to your TFSA. That last would not necessarily be an advantage due to you having lost the ability to use the dividend tax credit.
You’ve got a decision to make, an a few things to consider before you do it.
Question: What’s the best way to save my money?
Which is better for a short term savings? I have $4000 to put aside for my wedding in 2 years. Should I put it in a GIC or a tax free savings account?
Answer: I would avoid GIC’s as they are paying next to nothing on a 2 year term. A proper TFSA should be used for your goals, not one of those interest baring ones.
Question: Putting more money into a TFSA than $5000?
I was looking for a short-term savings account and ING offers one at 3%. It’s their tax-free savings account. It says you can put up to $5000 a year into these accounts, tax-free. More than that and it is taxed.
Does anyone know how much additional amounts would be taxed? On revenue canada’s website it says: “If, at any time in a calendar month, there is an excess TFSA amount in your account, you will be subject to a tax of 1% of the highest such amount in that month.” Which is very confusing. Does this mean my investment will be taxed 1% per month or that the interest earned will be taxed 1% per month?
Answer: Revenue Canada will tax the highest excess balance of the month at 1%, not the interest.
Question: Can I transfer money from my checking account to my tfsa account?
Answer: If you haven’t already maxed out your TFSA, sure! Check your financial institution for what vehicles are available for TFSA investment. Doesn’t matter whether the money is coming from chequing, savings, etc…the only thing that matters for TFSA is the $5000 cap, and where to put your funds into (GICs, stocks, mutual funds, etc.)
Question: TFSA Clarification contribution room allowance?
I have maxed out 5K in 2009 in stocks in the TFSA. In 2010 lets say the stock grew to be worth 20K with the 5K allowance for the new year. If I sold that stock and reinvested it into another set of stocks would the government consider that as excess contribution and make it taxable? Ie. Only be able to buy only 10K worth of stock (2009 5K + 2010 5K
Answer: No your contribution limit has nothing to do with the amount of growth in the plan. Your contribution room at the beginning of the year is equal to unused contribution from previous years plus withdrawals from previous years plus your yearly increase in your dollar limit.
Question: Can I buy an RRSP then shelter it in a Tax Free Savings Account?
Answer: Getting into the technical aspects of this, an RRSP is not an investment. An RRSP is an investment holder and shelters the income generated. A TFSA does the same thing, but in a different way.
That having been said, an RRSP can hold the same type of investment as a TFSA, but the same property cannot be held by both at the same time.
So, no. An RRSP cannot be sheltered inside a TFSA, because an RRSP is already sheltering some sort of investment.
Question: Is the $5000 limit on TFSA automatically available to everyone?
Or does the individual have to earn, say, over $5000 of income during the tax year?
Answer: You can open a TFSA regardless of your income. The annual limit for 2009 was $5,000 and will go up with inflation in future years. If you do not use your full $5,000 you will be able to accumulate it and use it in future years. If you withdraw money from your TFSA, you can make up your withdrawals.
A TFSA can be in the same form as an RRSP account, so mutual funds, etc. are permissible.