TaxMatters@EY - February 2013
Do you have a tax-free savings account?
Bob Neale and Teresa Gombita, Toronto
In a 31 December 2012 press release, Finance Minister Jim Flaherty and Minister of National Revenue Gail Shea jointly announced the increase in the tax-free savings account (TFSA) annual contribution room to $5,500 as of 2013. They further noted that approximately 8.2 million Canadians have opened a TFSA account and that roughly 2.5 million contributed the maximum amount in 2011.
The following is an update of our article on TFSAs in the January-February 2012 issue of TaxMatters@EY.
Every Canadian resident (other than US citizens and green card holders) aged 18 and older should consider including a TFSA as part of their investment strategy. The tax benefit of these registered accounts isn’t in the form of tax-deductible contributions, but in the tax-free earning on invested funds.
For US citizens and green card holders, the decision is more complex, as the income earned in the TFSA must be reported on the individual’s US personal income tax return, so the tax savings may be limited and there will be additional US filing disclosures.
The mechanics of the TFSA are simple:
- You can contribute up to $5,500 annually ($5,000 prior to 2013). If you contribute less than the maximum amount in any year, you can use that unused contribution room in any subsequent year. The cumulative contribution limit for 2013is $25,500.
- Income and capital gains earned in the TFSA are not taxed, even when withdrawn.
- You can make withdrawals at any time and use them for any purpose without attracting any tax.
- Any funds you withdraw from the TFSA — both the income and capital portions — are added to your contribution room in the next year. This means you can re-contribute all withdrawals in any subsequent year without affecting your allowable annual contributions. Re-contribution in the same year may result in an over-contribution, which would be subject to a penalty tax.
Permitted investments for TFSAs are similar to those for registered retirement savings plans (RRSPs) and other registered plans. And, like RRSPs, contributions in kind are permitted. But be aware that any accrued gains on the property transferred to a TFSA will be realized (at the time of transfer) and taxable, while any accrued losses will be denied.
The Canada Revenue Agency (CRA) will track your contribution room and report it to you annually as part of your income tax assessment. If you over-contribute, as with RRSPs, the over-contribution will be subject to a penalty tax of 1% per month while it remains outstanding.
You’ll find more information on TFSAs and many other valuable tax-saving ideas in our popular guideManaging Your Personal Taxes: A Canadian Perspective 2012–13.
- Gift or loan funds to your spouse or partner so they can make their own contributions. The income earned on these contributions will not be attributed to you while the funds remain in the plan.
- You can also gift funds to an adult child for TFSA contributions. An individual cannot open a TFSA or contribute to one before the age of 18. However, when you turn 18, you will be permitted to contribute the full TFSA dollar limit for that year (currently$5,500 as of 2013).
- To pass your TFSA to your spouse or common-law partner, designate them as the successor holder so the plan continues to accrue tax free without affecting their contribution room.
- You can maintain more than one TFSA, as long as your total annual contributions do not exceed your contribution limit.
- Your annual contribution limit is composed of three components:
- The annual TFSA dollar limit of $5,500 ($5,000 prior to 2013)
- Any unused contribution room from a previous year
- The total amount of withdrawals from your TFSA in the previous year
- If you become a non-resident of Canada:
- You will not be taxed in Canada on income earned in the TFSA (foreign tax may apply) or on withdrawals from your plan
- No contribution room will accrue for any year throughout which you are a non-resident. In the year of your emigration or immigration, the annual TFSA dollar limit of$5,500 ($5,000 prior to 2013), without proration, applies.
- If you re-establish Canadian residence, any withdrawals while you were a non-resident will be added back to your TFSA contribution room in the following year.
- Consider holding your non-tax-preferred investments in your TFSA.
- Neither income earned in the TFSA nor withdrawals from it affect your eligibility for federal income-tested benefits (i.e., Old Age Security, the Guaranteed Income Supplement) or credits (i.e., GST credit, old age credit and the Canada Child Tax Benefit).