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The tax free savings account, or TFSA, has been around for six years now and there are still many Canadians that are not taking full advantage of this investment opportunity.
Part of the reason may be a misunderstanding about how a TFSA truly works and its benefits. Here are 10 important things to know about a TFSA.
1. You can invest money in a TFSA in a similar manner as you would a registered savings plan or retirement income fund. If you have a self-directed TFSA, you can buy stocks, bonds, mutual funds, exchange traded funds, GICs – among other investments.
2. All income, growth and losses that occur within a TFSA do not impact the owner's income or tax positions at all. When an investment makes money in a TFSA, the owner does not have to declare the gain on their income tax return. Alternatively, you cannot claim any loss that occurs to offset any gains in a non-registered account.
3. There is a yearly maximum amount that can be contributed. For 2014, the amount is $5,500. If you have not contributed the maximum for any given year, the unused allowable room is carried forward to future years.
4. If you have withdrawn any funds in the past, you can re-deposit the same amount into the TFSA providing you have waited until after the following January 1st. An example: You contributed $5,000 and it grows to $6,000. You then withdraw $6,000 in October. You can then increase your allowable contribution room the following January by $6,000. Whatever the amount that you withdraw – whether it is original capital, income or growth – can be put back in at a later time.
5. You can transfer in an existing investment into a TFSA provided that you have sufficient contribution room. Be aware, however, that transferring an investment from a registered retirement account to a TFSA does not shelter the withdrawn amount from being taxed as income. As always, any amount that is de-registered from an RSP or RIF is fully taxable as income. You can also make a contribution in-kind from a cash account. If there is a capital gain, it is considered a deemed disposition, and you have to declare the gain. If there is a capital loss involved, you can not declare it and apply against gains.
6. You can use the TFSA to help build additional retirement savings in addition to your RSP. If you have used up your RSP contribution room, you can consider using your TFSA as an extension of your retirement funds.
7. Withdrawing from the TFSA will not impact your Old Age Security income amount. The amount withdrawn is not added to income, and therefore will not cause some or all of the AOS to be clawed back.
8. Upon your death, the assets in your TFSA can be transferred to your spouse without affecting their existing TFSA or contribution allowance. The surviving spouse ends up with assets that are tax sheltered and those assets will be passed on to their estate or beneficiary without tax as well.
9. You can gift funds to your spouse or adult child so they can contribute to their own plans. It is better if the gift is in the form of cash. Be careful that if it isn't, the security is considered to be sold and the deemed disposition could be subject to taxation of the capital gain.
10. You can use the TFSA as an education savings plan alternative. There are not the qualified post-secondary education restrictions when you use the funds from the TFSA. This is a benefit if there is a possibility that a child will not ultimately attend a post-secondary institution. What you are sacrificing is the Canada Education Savings Grant (CESG), which is money paid by the government for contributions to registered education savings plans.
If you haven't taken advantage of putting funds into a TFSA because you either think you are too old or too young, or it doesn't make sense because it is a small amount, think again. The tax free savings account is available to all Canadian residents over the age of 18.
Consider opening one even if you can only put in a small amount. You don't have to contribute the maximum each year but if you do, at the end of 20 years with a 5 per cent return, your TFSA will be worth $186,016.
Nancy Woods is an associate portfolio manager and investment adviser with RBC Dominion Securities Inc. She is also the author of Globe Investor's Ask An Adviser series. You can send your questions to asknancy@rbc.com. For an archive of her Q&As, please click here.