Weekly Tax Tips
Consider Using Your Tax-Free Savings Account
Date: 7 Jan 2011
Since January 1, 2009, you have been able to incorporate the use of a new tax-paid savings vehicle, called the Tax-Free Savings Account (TFSA), into your mix of investments. The TFSA will allow you to save for many purposes, including shorter term savings goals such as buying a home or new car and longer term savings goals such as saving for retirement.
Canadian residents 18 years of age or older can open up a TFSA and contribute amounts to the TFSA up to the contribution room available. You will acquire a $5,000 contribution room every year (which will be indexed to inflation and rounded to the nearest $500 on an annual basis). Any withdrawals made in the previous year as well as any unused contribution room from the previous year will be added to the contribution room for the current year. A TFSA will generally be permitted to hold the same investments as an RRSP, including mutual funds, publicly traded securities, GICs, bonds and certain shares of small corporations. However, note that unlike RRSPs, there are additional restrictive rules for investments that are not available on the open market. You will be subject to penalties on any investments which are not permitted to be held in your TFSA.
During the year, a number of TFSA contributors were identified by the CRA as having made possible excess contributions to their TFSA. For many, this was because they had either used their TFSA as a savings account (moving funds in and out of the account repeatedly) or had moved amounts between plans without a direct transfer. In order to avoid making excess contributions to your TFSA and subjecting the excess balance to a penalty by the CRA, you should consider your timing when replacing TFSA funds withdrawn and ensure that direct transfers between your TFSAs are reported properly by your financial institution(s). It is worth noting that TFSA overcontributions will be subject to a penalty tax for excess contributions, calculated at 1% per month on the highest amount of excess TFSA contributions in that month. For a more detailed discussion of the problems associated with overcontributions to a TFSA and tips on how to avoid this problem, see the article “Tax-Free Savings Accounts: A Refresher” in our Tax Factor 2010-03 publication.
While contributions to a TFSA will not be tax deductible, income, losses and gains in respect of investments held within a TFSA, as well as amounts contributed, will not be included in computing income for tax purposes or taken into account in determining eligibility for income-tested benefits or credits.
Generally, if you make an interest-free loan or gift funds to a spouse to invest, the income on the investment will be attributed to you and taxed in your hands. In the case of funds used by your spouse to make a TFSA contribution, there will be no taxable income, and therefore, the attribution rules will not be a concern. The same will be true where you make an interest-free loan or a gift to an adult child so that they can invest in a TFSA. Loaning or gifting money to family members to contribute to a TFSA will be an important personal tax planning consideration.
For more information on TFSAs, read our Answering Your TFSA Questions bulletin.
This tax tip is a publication of BDO Canada LLP on developments in the area of taxation. This material is general in nature and should not be relied upon to replace the requirement for specific professional advice. The information in this tax tip is current as of 7 Jan 2011.
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