TFSA confusion

Still confusion over TFSA rules

July 14, 2017

Eight years after the creation of Tax Free Savings Accounts (TFSAs), we still regularly run into people who are confused by the rules and how to best take advantage of these plans.

Let’s try to maximize your benefit from this useful tax vehicle, as it allows you to earn investment income completely tax-free, and then withdraw that income in the future, also tax-free.

Apparently I am not alone in finding confusion, as the CRA reported last week that they are seeking $75 million in penalties, interest and taxes from taxpayers who have run afoul of the TFSA rules.

While some of those alleged scallywags are accused of running a business inside their TFSA, some 80% of the penalties are sought from regular taxpayers who inadvertently over-contributed to their TFSA. Let’s make sure that doesn’t happen to you.

The most important thing to remember is that if you make a withdrawal from your TFSA, you cannot put the money back until the next calendar year. Each January 1, your entire contribution limit is reinstated, plus you have that year’s contribution limit added.

The annual limits started at $5,000, grew to $10,000 under the Conservatives, and then were reduced back to $5,500 by the current government. That’s your limit for 2017.

When you add it all up, a person who was at least age 18 in 2009 has $52,000 of cumulative contribution room. If you have deposited more than that, then you will be subject to penalties.

The investor’s goal with the TFSA is to make it grow as fast as possible, within prudent investment guidelines. Since capital losses incurred inside the TFSA are not deductible against other capital gains or other income, you definitely want to avoid any permanent loss of capital.

On the other hand, purchasing prudent growth investments has really paid off for many investors. We have a great number of clients whose TFSAs have grown to $80,000, $90,000 or more, and all of that growth can be withdrawn tax-free.

Other investors have focused on the “savings” part of the title, putting fixed income investments into their TFSA, and sheltering the interest income from tax. Since interest income is otherwise fully taxable (unlike dividends and capital gains), this strategy also makes sense, although it significantly limits the potential advantage available by using the TFSA.

My suggestion is that if your TFSA is intended for long-term savings (more than five years), then you focus your equity investments in this account, rather than in your RRSP or non-registered accounts. There is potential to earn significant growth through dividend reinvestment and capital gains without paying tax on the growth or the ultimate withdrawal, which is compelling.

If you achieve high growth within an RRSP, you will pay more tax on your withdrawals. High growth in non-registered account is taxable each year, although deferred capital gains, inclusion of only 50% of realized capital gains and the dividend tax credit on the dividends make equity investments attractive there, as well.

If you over-contribute to your TFSA, the penalty is a 1% tax every month on the highest excess TFSA amount each month.

That is that something you want to avoid, so double check your notice of assessment, your online CRA account and your financial institution records before making a new contribution.

And no, Martha, you can’t double up contributions by using more than one financial institution.

CRA has also been chasing people they determine have been actively trading their TFSAs, alleging that they have been “carrying on a business”, that being an investment business. This is the same argument and criteria they use to disallow capital gains treatment on non-registered investments.

You probably won’t run afoul of these rules, but expect a lot of objection from many of the people they have accused so far, as the rules are very vague and open to wide interpretation, based on the facts of each case.

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Dollars and Sense is meant as an introduction to this topic and should not in any way be construed as a replacement for personalized professional advice.

Please consult legal, tax, insurance and investment experts for advice on your unique situation.

David Christianson, BA, CFP, R.F.P., TEP, CIM is recipient of the FELLOW OF FPSCTM Distinction, a portfolio manager and senior advisor with Christianson Wealth Advisors, a Senior Vice President with National Bank Financial Wealth Management, and author of the book Managing the Bull, A No-Nonsense Guide to Personal Finance.