Tax-Free Savings Accounts

Tax-Free Savings Accounts

Tax-Free Savings Accounts (TFSAs) allows adult Canadian residents to earn investment income (interest, dividends, and capital gains) on a tax-free basis.

Contributions may be made throughout the year. Starting in 2009, contribution room for taxpayers was $5,000 or above. TFSA contribution room builds up over time. You or your tax preparer may check your contribution room online. Be warned, however, that if you contribute to a TFSA, and then withdraw from the TFSA, the contribution room is lost until January 1 of the next year. So, if I took $100 out of my TFSA in September, I would have to wait to January 1 of the following year to use that $100 of room.

The penalty for overcontributing to a TFSA is 1% per month on the highest excess. Let’s say I contributed $100 too much. At 1% per month, if I made that mistake for a year that would be 1%/month x 12 months. That is 12% x $100 or $12. Twelve percent is a very high interest rate these days!

If you withdraw the funds from a TFSA, and then add the funds to another TFSA, this is an indirect transfer and may have tax consequences.If I take out $5,000 out of a TFSA and don’t wait until January 1 to add to another TFSA, I’ve overcontributed that $5,000. In contrast, if I am well under my contribution room for the year, not problem.

Instead, It is possible to transfer funds between two TFSA plans (or ‘trusts’) without any tax penalty or effect on contribution room. However, it must be a qualifying transfer that is a direct transfer. That means it must be  done very carefully between two financial institutions.

Reading the requirements at one bank, it may be a complex process, meaning five pages of paperwork. However, it is valuable in that it protects your contribution room and also transfers thousands of dollars safely between financial institutions. If you need help, the institution that wants your business may help you with this, or your tax preparer may help.

Sources: Income Tax Act Sections 146.2 and 207.02. CRA website.