Tax Free Savings Account

Tax Free Savings Account or ‘TFSA’ is an investment vehicle that allows Canadians who are 18 years of age or older to invest money tax-free. Any investment income, capital gains or other earnings are not subject to tax. The program started in 2009 with a $5,000 limit and over the years, the limit has increased each year.  As of 2021, the limit is $75,500.

Opening a Tax Free Savings Account

Canadians who are 18 years of age or older with a valid social insurance number (SIN) are allowed to open a Tax Free Savings Account. Once a individual reaches 18 years of age, they’re eligible to contribute up to the full TFSA dollar limit for that particular year. 

Contributing into TFSA

Contributing into a Tax Free Savings Account is limited by your contribution room. Each year, you would accumulate TFSA contribution room even if you do not file a tax return. The contribution room depends on the annual TFSA dollar limit for the year.

For example: Jeff is 53 years old. Since 2009, he has earned a TFSA contribution limit of $69,500. Jeff may be contribute up to $69,500 into his Tax Free Savings Account.

The goal of  the Tax Free Savings Account annual limit is to be indexed to inflation and rounded to the nearest $500.

Tip: You are not required to have earned income as you would in an RRSP to contribute into a TFSA. Unlike RRSP contributions, TFSA contributions are not tax deductible.

To determine your contribution room, You can visit MyCRA and log in through your online banking or call the Tax Information Phone Service (TIPS) at 1-800-267-6999.

Non-Resident Contribution Room

It’s important to note that if you’re a non-resident of Canada throughout the entire year, you would not be eligible to accumulate contribution room.

Over Contribution Penalty

If you over contribute above your TFSA limit during the year, you would be subject to a 1% tax penalty on the excess amount for each month the excess amount remains inside the TFSA. 

The CRA may send you out a letter informing you of your over contribution. If you receive such a letter, the proposed course of action should be to remove the excess amount as soon as possible.

Example: Jeff has TFSA contribution room of $63,500. In March, Jeff over contributed $5,000 into his TFSA for a total contribution of $68,500. In June, he noticed the error when he received a letter from the CRA. His tax penalty is $150. (1% * 5,000 = $50 * 3 months = $150.)

Honest Mistake – If the over contribution amount arises due to an error, the CRA may waive or cancel the taxes owed. However, each situation is unique and would require review at the time.

Withdrawing from TFSA

Withdrawals from TFSAs are permitted at any time, pending on the type of investment held inside the TFSA. For example, a if you’re holding a 3 year GIC inside the TFSA, you would have to wait until the GIC matures before withdrawing.

When you withdraw funds from a TFSA, you do not reduce the available contribution room, until January 1st of the following year. Annual withdrawals can be added back the following year.

For Example: Jeff has contributed $50,000 into his TFSA. He decided he wanted to withdraw $5,000 from his TFSA. Jeff’s total contribution is still $50,000 even though he withdrew $5,000. On January 1st of the following year, pending no other contributions, Jeff’s total contribution will be $45,000. 

Withdrawing and contributing in the same year is recommended only if you have available contribution room. If you’re capped in contribution room and then proceed to withdraw $5,000 but only to deposit it back a couple of days later, you may be penalized up to 1% per month on the excess amount. You can only contribute back the amount withdrawn on January 1st of the following year.

Multiple Tax Free Savings Account

Be aware that when you have multiple Tax Free Savings Accounts at different institutions, you must keep track of your contribution room. No matter where your TFSAs are located, your contribution room is fixed as all the financial institutions would report your withdrawals and contributions to the CRA at the end of the year.

Transfers between TFSAs

Transfers between TFSAs held at different institutions is permitted and no tax consequences would arise. The transfer could be done “in-cash” meaning the holdings would be liquidated or “in-kind” where the investment holdings would stay as is.

Tip: When transferring from a non-registered account to a TFSA, you may realize capital gains. 

Taxes at Death

With a Tax Free Savings Account, you can choose to name a beneficiary or a successor holder. Both situations would enable you to avoid probate fees but only one designation would avoid tax implications. 

Designating Spouse as Successor Holder

If you’ve named your spouse as a successor holder, upon death, your TFSA would become their TFSA and the account would remain tax free. No impact would occur on her TFSA contribution room and the account would not pass through the estate and there would be no probate payable.

Keep in mind that you can only designate your spouse or common law partner as a successor holder. A person other than spouse would be considered a beneficiary.

Designating Spouse as Beneficiary

If you’ve named your spouse as a beneficiary of your TFSA, the value of the account on date of death can be paid to them or their TFSA, tax-free. However, if the TFSA rises in value after your death, the increase in value would be considered a taxable amount and would be reported on T4A slip and would be included in their income for the year of receipt.

Your spouse must transfer your TFSA into her TFSA by December 31st of the year after death. The market value at the date of death would be considered “exempt amount” and would not impact their TFSA room.

Designating Estate as Beneficiary

If you decide not to name a beneficiary, the default option would be “estate”. If estate, probate fees would be payable to the particular province of residence in order to validate the will and distribute the TFSA proceeds accordingly to the beneficiaries of the will. Growth in the TFSA after the date of death would be taxable to the estate.