A tax free savings account (TFSA) is a registered savings account that allows individuals to save a set amount of money on a yearly basis and invest that money with no tax payable. The aim when TFSAs were created by the Government of Canada was for people to set aside money to invest. Gains made on that investment are non-taxable.
TFSA Basics
An Individual who is 18 years of age or older that has a valid Canadian Social Insurance Number is eligible to open a Tax Free Savings Account and may make an annual contribution up to the limit set by the CRA ($5,000 for years 2009 & 2010). TFSA contribution room accumulates every year commencing with the 2009 calendar year that an eligible individual was a resident of Canada at any time during the year. It is not necessary to set up a TFSA or file a tax return to earn contribution room. You may open a TFSA any time in the future and contribute any amount up to your accumulated contribution room. For example, in 2016 an eligible individual could open a TFSA and make a deposit of $40,000 (8 x $5,000) assuming no inflation. However, the TFSA contribution limit is indexed to the inflation rate and rounded to the nearest $500.
Transfers between Tax Free Savings Accounts
You can have more than one TFSA at any given time as long as the total amount contributed to all your TFSAs during a year is not more than your available TFSA contribution room for that year. If you have more than one TFSA, you can transfer funds between them without affecting your TFSA contribution room, as long as you arrange for the transfer to be done directly between the TFSAs. This would be considered as a qualifying transfer, and would have no tax consequences. If you withdraw the funds from one TFSA and subsequently contribute that amount to another TFSA, the subsequent contribution will be considered a separate contribution that will reduce your TFSA contribution room for the year. If you wish to transfer your TFSA from one financial institution to another you should contact your financial institution for additional information.
An account holder is the only person allowed to contribute to a TFSA. You can, however, give your spouse or common-law partner money to contribute to their own TFSA without the contribution or any earnings being attributed back to you
Self Administered Tax Free Savings Accounts
It is possible to set up a self-administered TFSA. Generally, the types of investments that will be permitted in a TFSA are the same as those permitted in a registered retirement savings plan This would include cash, mutual funds, securities listed on a designated stock exchange, guaranteed investment certificates, bonds, and certain shares of small business corporations. Investments that are not at arms length from the account holder are prohibited. If a non-qualified investment is acquired within a TFSA or when a previously acquired qualified investment becomes non-qualified, a one-time tax is payable by the holder of the account. The tax is equal to 50% of the fair market value of the property at the time it was acquired or it became non-qualified. Any earnings or increase in value reasonably attributable to a “deliberate excess contribution” will be considered be an “advantage” and treated accordingly. If the holder of a TFSA or a person not dealing at arm’s length with the holder was provided with an “advantage” in relation to their TFSA during the year, a tax is payable equal to the fair market value of the benefit or the amount of the loan or debt.
Earnings and Withdrawals from Tax Free Savings Accounts
Generally, interest, dividends or capital gains earned in respect of investments in a TFSA are not subject to tax either during the period held in the account nor when withdrawn. Earnings on TFSA investments do not affect the account holders TFSA contribution room for any year. Accumulated earnings and contributed amounts may be withdrawn from a TFSA at any time for any reason without affecting an account holder’s eligibility for federal income-tested benefits and credits. Old Age Security benefits, Guaranteed Income Supplement or Employment Insurance benefits will not be reduced as a result of the income earned in or the amounts withdrawn from a TFSA. Earnings and withdrawals will not affect eligibility for federal credits, such as the Canada Child Tax Benefit (CCTB), the working income tax benefit (WITB), the goods and services tax/harmonized sales tax credit, or the age amount. An account holder is not required to report any contributions to or withdrawals from a TFSA on his or her income tax return.
You cannot contribute more than your TFSA contribution room in a given year even if you make withdrawals from the account during the year. Withdrawals from the TFSA during the year will be reflected in your contribution room in the following year. For example, if you have contributed the maximum allowed to your TFSA in a given year and make a withdrawal but decide to redeposit some of the amount withdrawn in the same year, you will have over contributed by the amount redeposited. Over-contributions are subject to a tax equal to 1% of the highest excess TFSA amount in the month, for each month you are in an excess contribution position.
Nonresidents holding a Tax Free Savings Account
An individual cannot accumulate TFSA contribution room for any year during which the individual is a nonresident of Canada throughout the entire year. If you are unsure of your residential status you should consult a tax professional at Aylett Grant. A mistake n making a TFSA contribution can be expensive. If you become a non-resident of Canada, or are considered to be a non-resident for income tax purposes, you will be allowed to keep your TFSA and you will not be taxed in Canada on any earnings in the account or on withdrawals from it. However, if you have become a resident of the United States, for example, you would be taxed in the US on any earnings within the TFSA and would be subject to FBAR regulations.
You can contribute to a TFSA up to the date that you become a non-resident of Canada. The TFSA dollar limit is not pro-rated in the year of emigration or immigration. Any withdrawals made during the period that you were a non-resident will be added back to your unused TFSA contribution room in the following year, but will only be available if you re-establish your Canadian residency status for tax purposes. If you make a contribution, other than a qualifying transfer or an exempt contribution while you are a non-resident, you will be subject to a 1% per-month tax for each month the contribution stays in the account.
Taxes and Penalties Payable with respect to a Tax Free Savings Accounts
The CRA recommends that you keep records of your TFSA transactions to ensure that you do not exceed your TFSA contribution room. The CRA will also keep track of your contribution room and determine the balance of room at a particular time for eligible individuals based on information provided by you and the TFSA issuers. An individual that is not required to file an income tax return will not receive a notice of assessment showing TFSA contribution room unless he files. Most TFSA holders have no tax payable related to their TFSA investments, and no TFSA tax return needs to be filed. However, when TFSA tax penalties are applicable for a year an RC243 (Tax-Free Savings Account (TFSA) Return), must be filed by June 30 of the following year. Any tax owing must be paid by that date.
When there is a breakdown in a marriage or common-law partnership, an amount can be transferred directly from one individual’s TFSA to the other’s TFSA without affecting either individual’s contribution room provided certain conditions are met. On the death of an accountholder a TFSA can be transferred to a surviving spouse.
AG TAX LLP Can Help
If you have any other tax-related queries, and/or need assistance with tax planning/filing please contact AG Tax. Our tax professionals are highly-experienced with U.S. and Canadian tax laws and can provide you the right guidance to handle your tax situation.
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