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Tax Free Savings Account (TFSA) Canada: Details & Strategies


The TFSA, or Tax Free Savings Account Canada, is here!

The Tories have promised something for investors since they were elected. The biggest election promise that I was hoping for this year was the capital gains exemption that they spoke of a couple years back. The plan was that investors could carry forward their capital gains taxation provided that the money was reinvested within 6 months. We can all see the benefits of this type of taxation, but we can also see the immense amount of additional paperwork and cost required from the government.

You probably know by now that the new budget does not include the capital gains exemption. However, there is a big bright spot in the budget for investors, that is the introduction of the Tax Free Savings Account (TFSA). I’m actually pretty excited about this account as it has MANY possibilities.

The Details:

  • Starting 2009, anyone aged 18 or older can contribute $5000/yr to the TFSA.
  • The TFSA can grow and be withdrawn completely tax free.
  • You never lose contribution room even when withdrawn.
  • Withdrawals can be made at ANY TIME with no withholding tax.
  • Contribution room can be carried forward indefinitely.
  • You can contribute to a spousal TFSA, and they can withdraw from it tax free (income splitting).
  • Withdrawal income does not affect government benefits like OAS, GIS, or CCTB.

The Fine Print:

  • Contributions are not tax deductible.
  • Capital losses cannot be claimed.

The Possiblities:

  • The account can be used as a simple savings account where interest can grow tax free.
  • This could be an opportunity for stock trading pros to utilize their options/shorting strategies without their gains being taxed as income.  Thus far (as of Jan 2, 2009), Questrade is the first discount brokerage to offer a tax free trading account.
  • An opportunity for income splitting where couples now have double the TFSA room to play with.
  • Invest in strong foreign dividend companies and withdraw the dividends TAX FREE. Right now, if you receive foreign dividends, they are taxed at your marginal rate. If you put these foreign dividends in an RRSP, they grow tax free, but you are taxed when you withdraw. The TFSA provides a great way to get exposure to those juicy American dividends, tax free at that.
  • Invest in higher yield bond funds/income trusts and withdraw distributions as a tax free income supplement.
  • Opportunity for non-registered portfolio rich seniors to move their dividend paying stocks into a TFSA to prevent OAS reduction.

How does this affect The Smith Manoeuvre strategy?

According to Jonathan Chevreau, the interest used to borrow for TFSA contributions are not tax deductible. Along with that, the contribution limits are restrictive for a full fledged leveraged account. These factors make the TFSA not ideal to use with The Smith Manoeuvre.

Other TFSA resources:

Photo credit: JeanPierreG

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FrugalTrader About the author: FrugalTrader is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 172 comments… add one }

  • Showtime August 18, 2011, 1:03 pm

    George, thx for the reply. That is interesting. Do you have a link to CRA or similar ~official source that details this…or perhaps you know firsthand because CRA has calculated your own limit that way? Every example I’ve seen from CRA so far just shows withdrawals equal to or less than the annual contrib limit. Thx.

  • chad September 11, 2011, 7:59 pm

    is XIN worth holding in a TFSA????

  • Donna March 2, 2012, 11:27 am

    Hello

    I hold dual Canadian/USA citizenship. I am want to set up a TFSA but have heard that the IRS tax treatment is not very kind for these investments. Can you please spell out what I am to expect?

    Thanks

    Donna

  • oldnestor April 12, 2012, 11:26 pm

    Perhaps somebody has already commented on the following in the 193 posts above?–

    ‘Invest in strong foreign dividend companies and withdraw the dividends TAX FREE. Right now, if you receive foreign dividends, they are taxed at your marginal rate. If you put these foreign dividends in an RRSP, they grow tax free, but you are taxed when you withdraw. The TFSA provides a great way to get exposure to those juicy American dividends, tax free at that’

    Remember that under the US / Canada tax treaty, TFSAs–unlike RRSPs–are not considered to be a pension trust. This has an effect on the amount of withholding tax Uncle Sam skims off the dividend. If you receive $10 dividend from a US company in a RSP, the withholding tax is 0%, nada. On the other hand, because the TFSA is not recognized as a pension trust, a 15% withholding tax will be taken off US dividends in a TFSA. That is to say, the $10 becomes $8.50. So the juicy American dividends are not quite tax free because there is a withholding tax.

    To me, the RSP is the best place for the juicy American dividends. Second best would be the TFSA or non-registered account. How the tie breaker would be decided would in part depend on one.s marginal tax rate in the non-registered account, seeing that foreign dividends will be taxed at the marginal rate: i.e. if the marginal rate is below the 15% withholding tax, then the non-registered account would be preferable. If one.s marginal rate is higher (this would be most people), then the TFSA would be second best after the RSP. And it will have to be considered as well that capital gains would be completely sheltered in both RSP and TFSAs. Some food for thought.

  • Johnny Canuck October 25, 2012, 4:08 pm

    I am consideering using the following combined TFSA / RESP strategy. Do you think this is a good idea or some variation of this?

    Step 1 – contribute max amount to TFSA each year in January
    Step 2 – withdraw the increase in TFSA value each year in December
    Step 3 – contribute the TFSA withdrawal amount to RESP in December and get the 20% CESG grant

    Repeat the process while contributing back the withdrawal amount to TFSA

    Here is a table with hypothetical situation (married couple, both working, start with $40K in TFSA between them, and earn 5% annually in the TFSA, 2 kids – target RESP contribution of $5K annually to get $1K CESG)

    Year TFSA January TFSA December Xfer to RESP RESP CESG
    2012 40,000 42,000 2,000 400
    2013 52,000 54,600 2,600 520
    2014 64,600 67,830 3,230 646
    2015 77,830 81,720 3,890 778
    2016 91,720 96,310 4,590 918
    2017 106,310 111,625 5,000 1,000
    Subsequent years
    +15,000 5,000 1,000

    Note: the TFSA contribution limit is assumed static at $5K, but I know that it will increase eventually. This is just to illustrate the point

    After 6 years, 106,625 in TFSA and 25,570 in RESP

  • Johnny Canuck October 25, 2012, 4:38 pm

    Sorry, I don’t know how to display the numbers as a table.

    But the general gist is that you save up during the year to make next years TFSA contribution and eventually the TFSA income entirely funds the RESP max contribution.

    I did not discuss RRSP, but it assumes that you are contributing to an RRSP as well as previously stated the RRSP/TFSA combo is best tax strategy and RESP falls further down the list.

  • Kit December 3, 2012, 9:16 am

    Hi, question about contribution room…

    If I withdrew $2,000.00 in September 2011 while contributing $5,000.00 in January 2012, will I be able to contribute additional $2,000.00 in 2013 for total of $7,500.00 ($2000 + $ 5500)?

  • Tax Free Savings Account December 3, 2012, 12:50 pm

    @Kit

    Yes. Any leftover contribution room from one year, is carried over to the next year. So in 2012 you had $7000 contribution room ($5000 + $2000 that you withdrew in 2011). You then contributed $5000 in 2012 leaving $2000 in leftover contribution room that will be carried over into 2013. So your contribution room for 2013 will be $5500 + $2000 = $7500.

  • Vivianne February 7, 2013, 4:09 pm

    I am being charged by my institution at $50 plus HST rate to have this TFSA account. Do all Institutions charge to have this type of account?

  • Guillaume December 7, 2014, 4:15 pm

    When transferring a TFSA from one financial institution to another, the losing financial institution typically charges a Transfer-Out Fee (sometimes to the tune of $125). The losing financial institution takes the Transfer-Out Fee from the TFSA.

    Question: How does that affect the remaining contribution room on the TFSA? Can you re-contribute the $125 without penalty?

  • Seth December 27, 2014, 9:07 pm

    I find it shocking how years after the TFSA was introduced, we still have so much confusion surrounding it. The personal contribution room / withdrawal rules are actually relatively simple. Here’s a pretty clear explanation for how it all works: http://tfsahelper.ca/general-tfsa-information/your-personal-contribution-room-limit/

    I think the biggest question about the TFSA is what will happen in 2015 if the Conservatives don’t win the federal election. Although I don’t think the Liberals would scrap it anytime soon, I do wonder if the increased limit to $10k annually that Harper promised once the books are balanced, would be…

  • Guillaume December 29, 2014, 11:14 am

    Seth: Are you saying that the Transfer-Out Fee is to be treated as a Withdrawal? That was the essence of my question. My thoughts are that it should indeed. Looking for confirmation.

  • Guest January 16, 2015, 10:35 pm

    The dividends earned from US based company withing TFSA is subject to tax at source, i.e., they withhold tax before crediting it to your account. Don’t they? Am I missing something here?

    According to your blurb above, you say juicy US dividends can grow tax free and withdrawn tax free. My understanding is correct?

    • FrugalTrader FrugalTrader January 18, 2015, 1:26 pm

      @Guest, from my experience in withholding tax, you will see the full dividend come into your account, then the withholding tax taken out right after. But yes, you can withdraw from your TFSA tax free.

  • DAI FURUTA January 26, 2015, 4:03 am

    Hmmm, I want to open TFSA with RBC Direct Investing yet I have not done…
    So it is tax free but you are saying dividend will be taxed. so it is not really tax free then??? Kinda confusing…
    “Invest in strong foreign dividend companies and withdraw the dividends TAX FREE. Right now, if you receive foreign dividends, they are taxed at your marginal rate. If you put these foreign dividends in an RRSP, they grow tax free, but you are taxed when you withdraw. The TFSA provides a great way to get exposure to those juicy American dividends, tax free at that”

  • Guest January 26, 2015, 10:49 am

    Put it his way – if it is a foreign stock, dividends are declared, after tax for that corporate entity. Your tax is withheld at source before depositing in your account. So, yes you are paying tax. But remember – this applies to foreign entities only. Most people invest in US for their “juicy” dividends. So you are paying tax now and withdraw tax free later.

    That said, why not choose only Canadian companies?. There are a few excellent ones out there. The dividends are declared by these Cdn. companies as grossed up. In a away you are paying tax in this situation too. Bottom line? Death and taxes are inevitable. TFSA is good for a long term holding and with DRIPS (dividend reinvestment). Watch it increase phenomenally over time.

    In a cash account, (non registered) similar scenario will attract taxes and the dividends are treated at lower tax rate.

    In Tfsa, does not pay taxes. That’s where the difference lies. Of course you know the similar situation in RRSP will attract taxes later when you withdraw. Another difference between TFSA and RRSP – you are investing after tax dollars in TFSA. In RRSP, your money is before taxes but you pay taxes later. Any which way you cut it, you cannot escape taxes. This is my take on this. If I am wrong, anyone in this forum can please correct me.

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