Tax Free Saving Accounts (TFSA)

Contrary to its name, it doesn't have to be a savings account! In this article I'm going to explore the TFSA with you, going in-depth to give you a bit more information. It seems a lot of folks are still confused about their contribution limits and how it works. According to an article I have just read from Google Finance, "the Canada Revenue Agency recently sent 65,978 mailouts to taxpayers who apparently put too much money into their TFSAs in 2012." 

The penalty of over contribution is 1% per month of which your total contributions exceed your available contribution room. The CRA will calculate the tax penalty using the highest overage each month in applying the 1%.

The TFSA mechanism was introduced in 2009. For the first four years, $5,000 of new contribution room is added annually each year. For the year 2013, that annual contribution room was bumped up to $5,500 in order to reflect inflation. If you recall from one of my previous articles, the TFSA contribution room will only move up in $500 increments when adjusting for inflation, so you won't see an increase every year unless the inflation was large enough. Your contribution room accumulates starting from the later of the year you turn 18 years old or 2009. Here's an example:

Billy Jean turned 21 years old in the year 2009, it is now 2013 and assuming he has never contributed into a TFSA, how much does he have available for his contribution room? ... He has $25,500! ($5k x four years + $5,500 for 2013)

What if he turned 17 years old in the year 2009? Then he would have $20,500 because he wouldn't have accumulated the $5,000 in 2009.

What can you invest in?

Despite its name, it doesn't necessarily have to sit in a savings account. In fact the name TFSA is more like a tag you add on to a type of investment to indicate that it is being treated differently for tax purposes. You can have a TFSA for mutual funds, stocks, bonds, and GICs (although I dislike GICs!).

Key things to note:

• If you're not a Canadian resident or a "deemed Canadian resident", you cannot setup a TFSA
• Whatever you contribute is not deducted from taxable income in your tax returns
• Consequently, whatever you take out is also not taxed, neither is the growth within the account
• Whatever you take out in a given year is added back to the contribution room of the following year (both the principal and the gain portion gets added back)

Unlike an RRSP, there isn't a $2,000 grace amount so be careful of over contribution! 

-TT

Considering RRSP vs TFSA? Check out my earlier article here: http://ttfinancialadv.blogspot.ca/2013/05/rrsp-or-tfsa-better-option.html