Since the creation of the TFSA a few years ago (2009), several Canadians are wondering about which account is the most profitable for them: RRSP or TFSA?

The answer is not the same for each individual. In fact, it greatly depends on your overall current financial situation and your financial situation at retirement. For example, if you have a high income while you work and have a defined contribution pension plan, chances are that your marginal tax rate will still be high at retirement. Your pension plan along with OAS and CPP will probably hit over 50K. Therefore, withdrawals from your RRSP will be taxed at a high rate compared to a non-taxed TFSA withdrawal.

Before I go with more example, please consider the TFSA Vs RRSP rules chart below:

TFSA Vs RRSP Comparison Chart

Now that you understand both RRSP and TFSA rules, let’s take a look their pros and cons. I’ve selected them according to their distinction. For example, we all know that both accounts are tax sheltered; therefore, there is no point of mentioning it in both. Let’s look at TFSA Vs RRSP for the difference:

Most Important RRSP Pros

-          The feeling of getting a big check from the Government (since RRSP contributions are tax deductible).

-          The “obligation” of keeping RRSPs for retirement (since RRSP withdrawals are taxable, it is not tempting to withdraw your money prior to retirement).

-          This is where all US stocks should be hold (since it’s the only type of account where you don’t pay taxes on US dividends).

Most Important RRSP Cons

-          You can’t run away from the tax guy (RRSP withdrawals are taxable).

-          RRSPs are not flexible in term of withdrawals (Besides LLP and HBP, all withdrawals cannot be reimbursed).

-          You can leave money on the table at retirement (for low income individuals, RRSP withdrawals could result in a diminished Guaranteed Income Supplement (GIS) check form the Government).

Most Important TFSA Pros

-          It’s more flexible than a contortionist (You can withdraw money from the TFSA at any moment without being taxed and you have the ability to reimburse the amount withdrawn upon the next calendar year).

-          It’s never taxed (this is important for both high income earner and low income earner at retirement. While the first group will save due to their high marginal tax rate, the latter will be granted by additional Government help such as the GIS).

-          You can grow your contribution room upon withdrawals (please read about TFSA Contribution to see its full potential).

-          It’s a great way to do investment income splitting with your spouse (attribution rules don’t apply on TFSA since nobody is taxed. Therefore, you can do spousal contributions without any impacts on your tax report).

Most important TFSA Cons

-          It doesn’t count as a retirement account (this means that US dividend stocks are subject to withholding taxes of 15%).

-          Saving potential is limited (The current TFSA contribution limit is set at $5,000 per year. This is not an important amount compared to one’ saving ability).

-          You may use your TFSA the wrong way (there is a lot of advertising to use your TFSA as an emergency fund or savings account at a low interest that doesn’t even match inflation. Please check out the TFSA investing strategies to invest better).

Is there a clear winner when you match-up TFSA Vs RRSP? Not really! It definitely depends on how you will use your account and what your financial situation is. If you have any questions, please use the contact form, I’ll be happy to help you out!

Many investors see the tax free savings account as an incredible gift from the Federal Government. They are actually right! The TFSA is definitely an awesome investing tool everybody should be using. However, it’s not because you are driving a BMW that you can’t make an accident. The TFSA has its own pitfalls that investors must avoid. Here are the most common mistakes when it comes down to using the TFSA:

#1 Over Contribution

If you over contribute to your TFSA, you will be heavily penalized. In fact, each dollar contributed above the maximum allowed will be charged by a special tax of 1% per month (so 12% per year). I don’t think you can sustainably maintain a higher investment return than the tax you will be paying. This is why over contributing is definitely the biggest TFSA pitfall. If you want to know if you have over contributed to your TFSA, you can read the following article: TFSA Over Contribution.

#2 Considering Your TFSA as a Regular Savings Account

It’s kind of ironic to not consider a Tax Free SAVINGS Account as a Savings Account! Too many investors use the TFSA as an emergency fund or regular and transactional savings account. This means that instead of actively investing with their TFSA and save a substantial amount on their potential gains, they save taxes on a 1.25% – 1.50% money market fund interest. Forget about the money market fund and use the TFSA for “real” investment. If not, you are simply leaving a lot of money on the table.

#3 Investing in US Dividend Stocks

If you invest in US dividend paying stocks in your RRSP account, the dividend is tax free. This is because there is a tax treaty signed between the Canada and the US. But this treaty is in regards to registered retirement plan only. The TFSA doesn’t count as a retirement saving account. Therefore, a withholding tax or 15% will be applied on all US dividend paid. This is why you are better off using your RRSP to invest in US stocks and keep Canadian stocks only in your TFSA.

#4 TFSA Withdrawals Calculation

If you don’t know about this rule yet, I strongly suggest you read about TFSA withdrawals. In fact, if you withdraw from your TFSA this year, you need to wait for the next calendar year to be able to “recontribute” in the amount you have withdrawn. If you miscalculate your TFSA contributions and withdrawals, you might rapidly fall in the TFSA over contribution zone.

#5 TFSA Fees

When you open your TFSA account, make sure to read the fine prints. Many financial institutions will require a minimum amount of trades or to invest in their own products to save on “small account” fees. Since the TFSA limit is not super high yet, chances are that your TFSA account will not be showing a high balance. Fees applicable on low balance account may apply depending on where you opened your account.

As you can see, the TFSA is a pretty good investment tool in general but you still have to know how to use it correctly!

Since its creation, the Tax Free Savings Account (TFSA) has been misunderstood by many Canadians. Some thinks that a TFSA is like a normal savings account with you can earn little interest tax free. Some others think it replaces the Registered Retirement Saving Plan (RRSP). Some others think it was a tricky ways to gather vote by the Government and that it will be stopped in the next upcoming years.

I think it’s time to shed some light on what a tax free account really is.

Why the Government Created a Tax Free Account?

A tax free account is a type of investment account. Therefore, the main goal behind the TFSA is not piling money in a low interest savings account but to invest money tax free. Believe it or not, but the main reason why the Federal Government created a tax free account was to improve low income level individuals.

At retirement, people with the lowest level of income can benefit from the Guaranteed Income Supplement (GIS). Unfortunately, the GIS is subject to income restriction. If a retiree withdraws from a RRSP or a RIF account, this amount will be added to his overall revenues. Each withdrawal will reduce the GIS. This situation place lowest income retirees in a sad situation. However, if the retiree invests in a tax free account, he won’t have to add his withdrawals on his tax report and will be able to keep his GIS.

As nothing is perfect, the TFSA rules also benefit the richest level of the population. Since they have a higher saving ability, riche individuals are able to both maximize their RRSP and TFSA contributions. For them, the TFSA is another investment tool enabling them to save more taxes.

What is a Tax Free Account?

The Tax Free Savings Account is similar to the RRSP account in a sense that you can invest in several options (money market funds, bonds, certificate of deposits, stocks, mutual funds, etc.). As soon as the money is invested in the TFSA, the concept of tax simply disappears:

1)      There are no taxes deduction applied on the contribution

2)      There are no taxes charged on profit made in the account

3)      There a not taxes charged upon withdrawals

4)      There are also no taxes charged upon death of the account holder

5)      In other words; there are no taxes, period!

What Can I Do With My Tax Free Account?

This is definitely the most simple and flexible investment account that has been created by the Government. As opposed to the RRSP which was created for retirement planning purposes, the TFSA is more flexible. Since there are no taxes on withdrawals and that you can (but not forced to) reimburse your contribution at any time, the TFSA account can be used for short term or long term goals.

Here’s quick, list of things you can to with a TFSA:

1)      Save for a cash down to buy a house (in complement to the first home buyer plan)

2)      Build you emergency fund

3)      Save for kids’ education (you are better off with the RESP but the TFSA is more flexible)

4)      Save for retirement

5)      Save for vacation

While many articles written in newspaper and on the web suggest to use your TFSA for short term purposes (such as an emergency fund or vacation budgeting), I believe the full potential of a TFSA is reached if you hold your investment during several years. This is when the tax free impact will make a huge difference.

What Are the Tax Free Account Rules?

There is a set of simple rules around the TFSA. In order to facilitate your browsing through this site, we have gathers them all at the same place: TFSA Rules. In addition to this article, we also went deeper in a few rule details:

TFSA Contribution

TFSA Over Contribution

TFSA Limit

TFSA Withdrawals

As opposed to RRSP withdrawals, TFSA withdrawals are not taxed. The beauty of a TFSA is that it enables you to investment money tax free and benefits from the proceeds… tax free! This is why we call it a Tax Free Savings Account!

How Can I Make a TFSA Withdrawal?

You can easily withdraw money from your TFSA by requesting your financial institution to sell an investment held in your TFSA (be careful as Certificate of Deposits cannot be redeemed prior to their maturity date). Once you have cash sitting in your TFSA account, you can transfer the money tax free into your regular bank account. There won’t be any tax slip issued upon a TFSA withdrawal.

How Much Can I Withdraw From My TFSA?

As long as your investments are liquid, you can withdraw every single penny from your TFSA at any time. Since it is tax free, you can liquidate your account and close it at any time.

Are There Fees Related to a TFSA Withdrawal?

While there are no taxes, your financial institution could charge you fees for withdrawing money from your investment. Most TFSA accounts do not include feed for withdrawals but you may want to check with your financial institution before making any transactions.

Do I Have to Refund my TFSA Withdrawal?

There are no time limits to refund your withdrawals. In fact, you could withdraw $10,000 from your TFSA account today and never refund it back. At no time the amount withdrawn will be taxed. On the other side, if you withdraw money from your TFSA, this amount will be added to your next year contribution limit (please read TFSA contribution limit for more information).  For example, if you withdraw $10,000 in 2012 from your TFSA, your contribution limit for 2013 will be $15,000 ($10,000 from your TFSA withdrawal + $5,000 of new TFSA contribution).

You can basically open a TFSA account with any financial institution. But what happen if you are not happy with your advisor and you want to switch bank? Is the TFSA transfer form complicated? Will you be taxed? Who fill in the information on the TFSA transfer form?

The transfer of an investing account can sound complicated, read risky for some investors. Fortunately, the process has been made quite easy and straight forward. We tried to compile all the questions and answers regarding TFSA account transfer form one institution to another here:

Where Can I Find The TFSA Transfer Form?

The TFSA transfer form is similar to a RRSP transfer form if you have ever signed one. This is usually a one page document that needs to be completed by your financial institution.

Who Should Complete the TFSA Transfer Form?

As it is the case with the RRSP transfers, most financial institutions have their own copy of the TFSA transfer from ready. They will be more than happy to complete the information with you and take care of the transfer process. The form is a one pager document that is quite easy to understand.

Do I Need Other Document to Transfer My TFSA?

Ideally, a copy of your most recent TFSA account statement is required. This is because we can find all the required information for the transfer (account number, name and address of the company to send the form, current assets). The transferring institution might also request a TFSA account number prior to send the money. Therefore, it is preferable to open your new TFSA account prior to sign the TFSA transfer form.

Are There Fees Associated with a TFSA Transfer?

Depending on the type of investment and financial institutions, there might be fees related to a transfer. In order to limit the transfer fee, I suggest you call your current financial institution where you have you TFSA and request what the possible fees are. There are usually small transfer fees that the other institution will more likely pay for you. However, you are always better to double check that with your new institution and not take it for granted.

If you have invested in mutual funds you also might have selling fees. The best way to transfer your account is to do it “in kind” and not “in cash”. This is an option you can find on the TFSA transfer form.

How The TFSA Transfer Process Work?

The transfer process is straight forward: the financial institution where you want to transfer your account will send the transfer form to your previous institution. Then, they will take care of the follow-up and make sure they receive your holdings or check.

The previous institution will then advise the Government that the account has been transferred to another institution. You don’t have to complete any other form or report it on your tax report.

Will I be Taxed if I Transfer My TFSA?

There are no tax implications with a TFSA transfer.

Can I Transfer My TFSA Holding in a RRSP?

You can also transfer money invested from your TFSA to your RRSP account. The process is quite simple and handled by your financial institution. No taxes (capital gain and capital losses) are triggered on your investment upon the transfer. The good news is that you will still receive your tax deduction based on the amount of the withdrawal from your TFSA (regardless how much you have contributed). Keep in mind that all TFSA contribution creates additional contribution room the following calendar year. Therefore, there are no tax downsides to contribute to your RRSP from your TFSA (unless you need the money prior to your retirement!).

This article covers the rules on TFSA over contributions. If you are interested in knowing how a TFSA works, we suggest you read TFSA contribution first.

TFSA Contribution and Over Contribution

As previously mentioned on TFSA Savings, the maximum TFSA contribution per year is $5,000. There are no rules as to how many TFSA accounts you can open. Therefore, your financial institution will not monitor your TFSA contribution limit as they don’t know if you have contributed to more than one TFSA account with more than one financial firm. It’s then up to you to make sure you don’t over contribute.

TFSA Contribution Calculation

In order to avoid unnecessary calculations between TFSA contributions and TFSA withdrawals, Canadian Revenue Agency (CRA) is sending you once a year your TFSA contribution room. This is a document sent with your Notice of Assessment and your RRSP contribution limit. Throughout the year, only TFSA contributions will be added to assess the amount of your contribution. Therefore, your withdrawals will not count in the CRA calculation.

For example, let say you have received your TFSA contribution document showing a maximum of $8,000 for this year ($5,000 for 2012 + $3,000 from unused TFSA contribution limit from past years). You contribute through a lump sum of $8,000 as soon as you receive your document. During summer time, you withdraw $2,000 to fund your vacation. You won’t be allowed to refund this $2,000 until next year.

In fact, all TFSA withdrawals are calculated and reported on next year TFSA statement This is only one calendar year later that you are able to use the room created by the $2,000 withdrawal.

2 Ways to Over Contribute to Your TFSA

There are 2 ways to over contribute to your TFSA. The first one is to over contribute the current year limit (e.g. doing a TFSA contribution of $6,000 per year while you are allowed to contribute only $5,000). The second way is to consider your TFSA withdrawals as additional contribution room for the same year.

As previously mentioned in the example, your TFSA withdrawals are added to your TFSA contribution limit the following year only.

I Over Contributed to My TFSA, What Will Happen To Me?

The above mentioned rule has confused more than one Canadian back in 2009. Several investors were playing with their contribution limit by adding their withdrawals to their current TFSA contribution limit. Each time you withdraw from your TFSA, the amount is added to your TFSA contribution limit (read TFSA withdrawals to understand the mechanism). However, this amount is reported only the following year.

If you have over contributed to your TFSA, you will be charged by an extra tax of 1% per month on the excess amount of the contribution. For example, on a $1,000 excess contribution, your penalty will equal $10 per month until this matter is resolved. If it’s your case, we suggest you withdraw immediately the amount of excess contribution (and not the market value) in order to settle this problem.

• To pay the TFSA over-contribution penalty – Fill out CRA form RC 243 by June 30, 2010 (or the year after you are assessed the penalty).
• To remove excess amounts from your TFSA account – Contact your financial institution and ask them to withdraw the amount of over-contribution.

Following to our TFSA Contribution article, we are providing additional information on TFSA contribution limit. For an overview of the Tax Free Savings Account, we suggest you read our article about What is a Tax Free Account.

What is the TFSA Limit?

Each year the Federal government determine the TFSA contribution limit. This tax sheltered investment account was created in 2009 with a limit of $5,000. Each following year, the TFSA limit has been increase by the same amount. Therefore, the total limit is now set at $20,000 in 2012:

2009: $5,000

2010: $5,000

2011: $5,000

2012: $5,000

Total: $20,000 total contribution limit.

Please note that the $5,000 will be indexed following the inflation.

You Can Increase Your TFSA Limit

There is a way to increase your TFSA limit over time. In addition to the $5,000 per year, your TFSA limit is also growing through your TFSA withdrawals. Each time you make a TFSA withdrawal; this amount is reported and added to your TFSA limit of the following year. Therefore, if you withdraw $3,000 in 2012 from your TFSA account, your TFSA limit in 2013 will become $8,000. Until then,  you are not really increasing your TFSA limit as it is only money you already had contributed that you are allowed to refund.

However, there is a real way where you can increase your TFSA limit. Imagine that you have invested $5,000 in 2009 in your TFSA. After 2009, you have not invested more money in your TFSA. In 2012, your contribution limit is set at $15,000 (2010, 2011 and 2012 contribution added). If you have made a good move with you first $5,000, your TFSA account might be showing $9,000 ($5,000 coming from your TFSA contribution + $4,000 in profit). You are allowed to withdraw all your investment from your TFSA (e.g. $9,000 in this case). If you do not make any contribution in 2012, your TFSA limit in 2013 will not be $25,000 (2009, 2010, 2011, 2012 and 2013 contribution added) but $29,000 (2010, 2011, 2012, 2013 + the amount of your withdrawal in 2012 ($9,000).

In fact, each time you withdraw from your TFSA, this amount is being added to your TFSA contribution the following year. The amount is not related to your contribution. Therefore, if you have made a bad investment and your $5,000 worth $2,000 and you need to withdraw it. Your contribution limit will be increased by $2,000 the following year even if you had contributed $5,000 in the first place.

TFSA Limit Calculation as Follow:

+ TFSA contribution for the current year (currently established at $5,000 per year)

+ Unused TFSA contribution from the previous years (with no limit on the number of years you can go back).

+ TFSA withdrawals in the previous year

This calculation is made by the government and your TFSA limit is being sent to you at the same time you receive you notice of assessment (after filling your tax report in April).

The Tax Free Savings Account has been effective as of January 2009. Back then, the TFSA contribution was set at $5,000 per year. This means that you could contribute to your TFSA at any time of the year with a limit of $5,000. The amount of $5,000 will be indexed according to the inflation rate. Contribution limit will be rounded at each $500.

Can I do more than One TFSA Contribution Per Year?

Similar to the RRSP program (click here to read more about TFSA vs RRSP), you can contribute to your tax free account at any time of the year. Therefore, you can contribute by a lump sum of $5,000 or you can do multiple contributions throughout the year. An efficient TFSA strategy is to setup a systematic investment that matches your pay check in order to maximize your contribution. Be careful of not do a TFSA over contribution.

How Can I Contribute to My TFSA?

The TFSA program is quite flexible and allows Canadian investors to benefit from a tax free account in many ways. There are 2 ways you can make a TFSA contribution:

#1 Contribution in cash

You can contribute with money from your bank account or savings account. The contribution can come from your pay check, allowance, gift, heritance, spouse’s money. There are not rules as of to where to money has to come from. Please note that all profit from contribution are tax free.

#2 Contribution in kind

If you have a cash account, you can also transfer an existing investment (such as a stock, a bond or a mutual fund) into your TFSA account. The amount of the TFSA contribution will equal the market value of your investment at the time of the contribution.

Beware of the tax implication. If you contribute with an investment where you have a capital gain, you will be presumed realizing the capital gain by transferring your asset in your TFSA. For example, if you have bought a mutual fund at $2,000 and it is now worth $2,600 due to capital appreciation. Your TFSA contribution will be equal to $2,600 (leaving $2,400 left for the current year contribution limit) and you will be taxed on a $600 capital gain. On the other side, if you contribute with an asset showing a capital loss, you will lose your tax deduction for capital loss. Therefore, a mutual fund with a $1,800 market value and a book value of $2,000 will worth $1,800 in TFSA contribution but you won’t be able to use the $200 capital loss against a capital gain.

The best solution would be to realize a capital gain and a capital loss that will offset each other in your cash account. Then you wait 30 days and you can use this money to contribute to your TFSA.

Do I Get a Tax Return For My TFSA Contribution?

RRSP and TFSA are two different tax sheltered account (you can read more about TFSA Vs RRSP). One of their main differences is the tax implication linked to the contribution. When you contribute to your RRSP account, the amount of your contribution reduces your earned income. If you have already paid taxes on your total income, you will then receive a tax deduction from the Government.

When you contribute to your TFSA, you do not receive a tax deduction. Since TFSA withdrawals are not subject to taxes, contributions are not tax deductible either. To make it easier to understand, let just say that once you have contributed to your TFSA, there are no more taxes:

-          No tax deduction on TFSA contribution

-          No tax paid on income earned in your TFSA account (interest, dividend or capital gain)

-          No tax paid on TFSA withdrawals.

TFSA Over Contribution

If you exceed the amount permitted with your TFSA contributions, your account will be heavily penalized. You can read more about TFSA contribution to know how it works.

Created by the Federal Government in 2009, the Tax Free Saving Account (TFSA) is flexible, tax sheltered account where you can invest your money. While the RRSP was created for retirement planning and the RESP was created for education financing by the parents, the TFSA doesn’t have a specific purpose. You can use this account for short term savings (earning tax free interest) or as a complementary measure for retirement or education funding.

Tax Free Saving Account Rules

There are several simple rules listed below for your better understanding:

You must be a Canadian Resident and be over 18 years old to contribute to a TFSA.

Investment income earned within the TFSA is tax free.

There are no tax deductions on TFSA contribution.

TFSA withdrawals are not taxed.

TFSA withdrawals are not to be refunded (as opposed to the HBP in RRSP).

TFSA withdrawals can be put back into the TFSA in the future year (must wait for the next calendar year)

TFSA account can hold cash, mutual funds, stocks, bonds, GICs.

Income generated from TFSA doesn’t affect any social programs such as Old Age Security, Guaranteed Income Supplement and Canada Child Tax Benefits.

Funds can be given to spouse or common-law partner to be invested in TFSA without tax implication.

TFSA assets can be transferred to spouse or common-law partner without tax implication upon death.

TFSA account cannot be joint or spousal. Spousal contributions are allowed but do not count in the spouse’s contribution calculation.

The TFSA must be registered under an individual; it cannot be hold by a corporation.

You must have a SIN (Social Insurance Number) to open a TFSA account.

More info on TFSA Rules

Since some TFSA rules are more complicated than others, we have written a list of articles answering most questions about the following points:

TFSA Contribution

TFSA Over Contribution

TFSA Limit

TFSA Withdrawals

Note: this table is updated yearly according to the Canadian Revenue Agency (CRA). You can find the most updated information on the CRA website.

Once you have calculated your Federal Tax, you also have to calculate your provincial tax. Both taxes are added up to complete your Canadian income tax. You will notice by looking at the chart below that the tax rate and brackets vary greatly. Therefore, the Tax Free Savings Account may seem more advantageous in some province than others . Overall, investing tax free is definitely something you should consider as a Canadian.

2012 Provincial Tax