TFSA Rules You Need To Know

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Ryan O’Leary is a writer and former financial services professional. He writes about personal finance for Wealthsimple and his work has been featured by the New York Stock Exchange. Ryan holds a Bachelor's degree in International Business from University College Cork in Ireland.

First thing’s first: a tax-free savings account (TFSA) need not be a savings account. We're not sure who decided to call it that, but we think of a TFSA as a basket for saving or investing. You can pick what to put in your “basket” from an array of financial instruments—exchange-traded funds, guaranteed investment certificates, stocks, bonds and, yes, actual savings. The important part is: Whatever gains you make from the investments in that basket are tax-free.

You might be wondering, “Where’s the catch? This looks too good to be true!” Indeed, there are a number of rules attached to TFSAs. Luckily, we’ve covered the ones you need to know before enjoying sweet TFSA bliss.

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TFSA Contribution Rules

The maximum amount of money you can deposit into your TFSA annually currently stands at $6,000. This figure is called your TFSA contribution room. Thankfully, the total amount that you contribute is cumulative. This means that any unused contribution room will carry over from one year to the next. The actual amount you can add to a TFSA will go up each year, regardless of whether or not you deposit money. If the amount of money in your TFSA rises due to the growth of your investments or interest earned on savings, this does not count as part of your annual contribution. There's only one thing the Canadian government limits — how much money you put in.

Should you not have a TFSA, then you might just be able to contribute a grand total of $75,500 tax-free. That's provided you were eligible and at least 18 years old in 2009 – the first year the TFSA was available. If you already have a TFSA and have never taken out any money, you can keep adding to your account up until you hit your TFSA limit. And if you've withdrawn money from your TFSA in the past, don't fret, you'll get that room back, but not until the following year.

At any time over the course of a calendar year, if you contribute more than your allowable TFSA contribution room, you will be officially “over-contributing” to your TFSA, and you will be subject to a tax equal to 1% of the highest excess TFSA amount in the month, for each month that the excess amount remains in your account. In short, it’s best to stay within your TFSA contribution room.

There are a few ways to track your TFSA contribution room one of which is on the CRA website. Another is the old school DIY method which is favoured by Barry Choi, founder of Money We Have.

Although your MyCRA account tells you how much contribution space you have left in your TFSA, it's often inaccurate. You're better off logging things on your own in a spreadsheet so you don't overcontribute by accident.

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TFSA Withdrawal Rules

For the most part, you can withdraw any amount of money you like from your TFSA. The great news is that taking out funds from a TFSA doesn't reduce the total amount of contributions you have already made for the year. Withdrawals, excluding qualifying transfers and specified distributions, made from your TFSA this year will only be added back to your TFSA contribution room at the beginning of the following year.

Should you decide to re-contribute or replace the money you withdrew, within the same year, you can only re-contribute if you have available TFSA contribution room.

TFSA Eligibility

As long as your over 18 years of age and you have a valid SIN number, you're perfectly eligible to open a TFSA. A person determined to be a non-resident of Canada for income tax purposes can hold a valid SIN and be allowed to open a TFSA. However, any contributions made by a non-resident are subject to a 1% tax for each month the contribution stays in the account.

TFSA Investment Rules

For the most part, whatever is permitted in a Registered Retirement Savings Plan (RRSP), can go into a TFSA. That includes cash, mutual funds, securities listed on a designated stock exchange, guaranteed investment certificates, bonds and certain shares of small business corporations. You can contribute foreign funds but they will be converted to Canadian dollars which cannot exceed your TFSA contribution room.

Depending on the type of investment held in your TFSA, you may incur a loss in your original investment. Any investment losses within a TFSA are not considered a withdrawal and therefore are not part of your TFSA contribution room.

Just because it's called a TFSA, doesn't mean there's absolutely no tax at all. Rules apply and there are some instances where tax does come into the equation. For example, when you hold foreign investments that pay dividends.

The dividends of foreign investments are subject to non-resident withholding tax (NRT). Like any tax, this eats into the amount you actually make. But that doesn't mean you should rule out foreign dividend paying investments. It's important to have a diversified portfolio and this can mean having foreign dividend-paying stocks, particularly in a sector that might not be well represented on the Canadian Stock Exchange.

TFSA Stock Trading Rules

You may be surprised to learn that your trading activity could constitute a business, even if it’s done inside a TFSA. The tax rules mean that should a TFSA operate like a business then they have to pay income tax.

Recently, the Canada Revenue Agency (CRA) has focused their audits on taxpayers that are actively trading within their Tax-Free Savings account.

The CRA takes account a number of things into account when determining whether or not a TFSA is subject to income tax. These include the duration of the holdings, the frequency of the transaction and your intention to hold investments for resale at a profit.

In situations where one or more TFSA taxes are applicable, a TFSA return must be filled out and sent by June 30 of the year following the calendar year in which the tax arose.

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TFSA Rules On Death

Wondering what happens to you or a loved one's TFSA when you pass away? The types of beneficiaries for TFSA purposes are:

  • A survivor (spouse or common-law partner of the TFSA holder) who has been designated as a successor holder.

  • Designated beneficiaries (for example, a survivor who has not been named as a successor holder), former spouses or common-law partners, children, a designated subsequent survivor holder who is the new spouse or common-law partner of the successor holder, and qualified donees.

Determining the type of beneficiary can be affected by:

  • Designations which may have been made in the deceased holder's TFSA contract

  • The provisions of the deceased holder's will, if there is one

  • Provincial or territorial succession legislation

Buried in the boilerplate of the TFSA application form is the section where one names a beneficiary. You can name an individual as a beneficiary for an account right on the application form. However, it's also possible to name your estate as the beneficiary and leave it to your will to say which account assets go to whom.

For single or widowed individuals, anyone can be named as a beneficiary. The value of the plan at the time of death would go tax-free to that beneficiary. If the beneficiary takes the money in cash, that's the end of the story. If he or she wants to put it in a TFSA or RRSP, there must be contribution room to accommodate the money. Married or common-law individuals can choose anyone they want as a beneficiary or successor holder.

We reckon the best home for your TFSA is at Wealthsimple. We offer state of the art technology, low fees and the kind of personalized, friendly service you might have not thought possible from an automated investing service. You can learn more about our TFSAs here or get started here.

Last Updated January 8, 2021

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