1. What is a TFSA?
Purpose – The TFSA is a flexible savings plan that can be used (and re-used) for any savings purpose over a person’s lifetime. It is registered under the Income Tax Act, entitling it to special tax treatment. Compared to other registered plans, the TFSA has relatively few rules to understand and follow.
Investment options – Qualified investments are similar to RRSPs and other registered plans. Options include money accounts, deposits with a regulated financial institution and guaranteed investment certificates; stocks, bonds and most other securities listed on a designated stock exchange; and mutual funds and segregated funds.
2. Who can use it?
Eligible contributors – To use a TFSA, a person must be a Canadian resident over the age of 18. When you open an account, your financial institution will require proper identification, your Social Insurance Number (SIN) as a tax requirement, and other information according to securities regulations.
Age 18 contributors – A person must be 18 to open a TFSA, and will be entitled to the TFSA dollar limit (discussed below) for that full year, not pro-rated by birthday. If the person cannot enter a contract until age 19 if that is the province’s age of majority, the TFSA limit/room for the age 18 year carries forward.
Upper age limit – There is none.
Foreign citizens – Eligibility is based on being a legal Canadian resident, regardless of citizenship. For Americans (and possibly others), their home country tax rules may influence whether to use a TFSA.
3. How it works – Key tax features
In, within and out – Whereas RRSP contributions are deductible and withdrawals taxable, for TFSAs:
- Contributions are after-tax, meaning they are NOT deductible in calculating current income.
- Income and growth within the plan are NOT taxable.
- Withdrawals from the plan are NOT taxable.
Over-contributions – If your TFSA contributions exceed your TFSA contribution room recorded at the beginning of the year, you are said to have an excess TFSA amount. If this is the case at any time in a month, you are liable to a penalty tax of 1% on your highest excess TFSA amount in that month.
Non-resident contributions – If, at any time during the year, your TFSA contains contributions you made while a non-resident of Canada, you will be subject to a tax of 1% per-month on these contributions.
4. Contributions and withdrawals
TFSA dollar limit – As a Canadian resident who is 18 at any time in a year, you are entitled to the annual TFSA dollar limit. The limit was $5,000 from 2009-12, $5,500 from 2013-14, $10,000 in 2015, $5,500 from 2016-18, and $6,000 in 2019-20. It is indexed to inflation and rounded to the nearest $500.
Unused room – Your unused room is carried forward for you to use in any future year.
In-kind transfers – You may transfer securities in-kind to a TFSA, but the transaction may trigger tax. If it originates from a non-registered account, there is a deemed disposition at fair market value (FMV) that may result in a taxable capital gain. If the source is your RRSP, it will be treated as a withdrawal at FMV.
Credit for withdrawals – When you make a withdrawal, you get a dollar-for-dollar credit to re-contribute to your TFSA. The credit applies the following January 1st. If you re-contribute in the current year, you may exceed your contribution room and face the 1% penalty tax.
TFSA-to-TFSA transfers – If you want to move funds from one TFSA account to another, whether at the same institution or another, do so as a direct transfer so as not to affect your TFSA room. There is no prescribed form for this purpose, so some companies use their own form or use CRA Form T2033.
Loan interest – TFSA income is tax-exempt, so interest on a loan to invest in a TFSA is not deductible.
5. Life events, and death
Income splitting with spouse / common law partner (CLP) – Generally if you make a gift to a spouse/CLP that is put into passive investments, tax on that income will be attributed to you the giver. However, those attribution rules don’t apply if your spouse/CLP places the gifted money in a TFSA.
Relationship breakdown – A direct transfer of a TFSA to a separated spouse/CLP will not affect either person’s TFSA room. The recipient’s room is not reduced by the receipt, and the transferor receives no credit to recover room as this is not a withdrawal. You must be living separate and apart at the time of transfer, and the transfer amount must be pursuant to a separation agreement or court order.
Becoming non-resident – If you become non-resident, there is no tax on a TFSA at that event nor while you remain non-resident, and any earnings or withdrawals will still not be taxed in Canada. You will not accrue any annual room while non-resident. Withdrawals are allowed, and those will be credited toward room the following year, but you may only use that room if you re-establish Canadian residency.
Death: Designated beneficiary generally – You may designate one or more beneficiaries on the TFSA contract, and he/she/they will receive the plan value at date of death without any tax reduction. Any growth from time of death until the transfer is taxable to the beneficiary/ies.
Death: Spouse as designated beneficiary – If you die having designated your spouse/CLP as beneficiary on the TFSA contract, he/she may contribute and designate all or a portion of the payment as an exempt contribution to their own TFSA, without affecting their own unused TFSA room. Again though, any growth from time of death until transfer is taxable to the spouse beneficiary. To qualify for the rollover, transfer must occur before the end of the calendar year after the year of death.
Death: Spouse/CLP as “successor holder” – If you die having designated your spouse/CLP as successor holder, he/she becomes the new holder of the TFSA without affecting his/her existing TFSA room. This designation will be effective whether it is made on the TFSA contract or in the original holder’s Will. In this case though, the transfer is deemed to occur at the date of death, so any post-death growth will not be taxable as it will occur within the survivor spouse’s TFSA. Once more, to qualify for the rollover, transfer must occur before the end of the calendar year after the year of death.
Death: Spouse as estate beneficiary – A TFSA paid to the deceased’s estate may be subject to provincial probate tax. A spouse/CLP who has a sufficient financial entitlement as a beneficiary of the estate may make an exempt contribution with the same effect as being a designated beneficiary on the TFSA contract. Interim growth is again taxable to the spouse/CLP. To qualify for the rollover, transfer must occur before the end of the calendar year after the year of death.
Death: Unused TFSA room – Unused room cannot be transferred to anyone at death.