Starting in 2009, the Canadian government introduced a new type of registered account called the Tax-Free Savings Account (TFSA). Every Canadian 18 and over can invest $5,000 per year in this new registered account.
You do not need to have “earned income” to build up room as you do with an RRSP. Amounts contributed to a TFSA grow tax-free; however, unlike an RRSP, the amounts you contribute are not tax-deductible. That is the bad news. The good news is that when you take money out of your TFSA, 100% of what you take out is non-taxable.
One downside to a TFSA is that if you happen to lose money on your investment, there is no ability to “use the loss” to offset income or gains elsewhere.
How the Contributions and Withdrawals from a TFSA Work
The best way to illustrate how a TFSA works is by using an example.
- 2009 – you put in $5,000
- 2010 – say it grows and is worth $30,000 – you take out all of it – tax-free
- So, now you have $0 left in the account.
- What is the maximum TFSA contribution for 2011?
- The answer is $40,000
- How did I arrive at the sum of $40,000?
Remember the $30,000 withdrawal in 2010? You can put that $30,000 right back into your TFSA as long as you wait one year, ie. until 2011. Plus, you are also permitted to contribute $5,000 for each of 2010 and 2011, for a total of $40,000.
Each year, an additional $5,000 may be added. In addition, any gains that are withdrawn can be re-deposited to the TFSA in the following year or later. If you do not use your contribution room, it is simply added to your limit in the following year. For example, if you make no contributions for ten years, you can put in $50,000 all at once in year ten.
Which Investments Qualify?
The rules regarding qualifying investments in TFSAs are virtually identical to the RRSP rules. Examples include the following:
- Cash
- GICs
- Mutual Funds
- Stocks on prescribed exchanges such as TSX, NYSE, and the NASDAQ
- Government and Corporate Bonds
Who should use a TFSA?
A TFSA should be used by people who have little or no personal debt, like mortgages, credit card debt, car loans or personal lines of credit. Any interest you pay on these types of debts is usually not tax-deductible.
If you happen to have personal debts (you are in the majority if you do), you should use any excess cash you have to pay down your debt first before using a TFSA. If you already have non-registered savings or investments, you should probably look at opening a TFSA. However, if you have to take money out of your Professional Corporation (and pay the tax) to get the money into a TFSA, you’re better off leaving it in your company.
If you have any questions about TFSAs or any other registered product, please give us a call at TPC Financial Group at 1-888-315-0058.