Tax-Free Savings Account (TFSA)
A Tax-Free Savings Account is a new way for residents of Canada to set money aside, tax-free, throughout their lifetimes. Contributions to a TFSA and the interest on money borrowed to invest in a TFSA are not tax deductible. The income generated in the TFSA is tax-free when withdrawn.
Who is eligible
Any individual (other than a trust) who is at least 18 years old, who is a resident of Canada and has a valid Social Insurance Number (SIN) can be a holder of a TFSA.
How to Set-up a TFSA
You set up a TFSA through a bank, credit union or other financial service provider who is eligible to issue a TFSA. They are referred to as the issuer of the plan.
As the TFSA holder, you will need to provide your social insurance number (SIN) and date of birth to the issuer, so that the issuer can register your qualifying arrangement as a TFSA. Failing to provide this information or providing incorrect information may cause the registration of the TFSA to be denied, resulting in possible tax consequences.
You can have more than one TFSA at the same time, as long as the total amount of all contributions during the year does not exceed your TFSA contribution room for that year.
Types of investments allowed in the TFSA
Generally, the types of investments that will be permitted in a TFSA are the same as in a registered retirement savings plan (RRSP).
This would include mutual funds, securities listed on a designated stock exchange, Guaranteed Investment Certificates (GICs), bonds, and certain shares of small business corporations.
You can also make "in kind" contributions to your TFSA, as long as the property is a qualified investment. We will consider that you have disposed of the property for its fair market value (FMV) at the time of the contribution. If the FMV is more than the cost of the property, you will have to report the capital gain in your income tax return. However, if the cost is more than the FMV, the resulting capital loss cannot be claimed. The amount of the contribution will be equal to the FMV of the property.
Contributing to a TFSA
In order to contribute to a TFSA, you must be at least 18 years old, a resident of Canada and have a valid social insurance number (SIN) at the time your Tax Free Savings Account is opened.
TFSA dollar limit
For 2009, if you are eligible, you can contribute up to $5,000 to your TFSA. After 2009, the annual TFSA dollar limit will be indexed to the inflation rate.
The indexed amount that will be provided will be rounded to the nearest $500 increments. For example, assuming that, in 2009, the inflation rate is 2%, the TFSA dollar limit would remain at $5,000 for 2010 and 2011, but would increase to $5,500 in 2012.
TFSA contribution room
The TFSA contribution room is made up of:
Based on information provided by the issuers, the Canada Revenue Agency (CRA) will determine the TFSA contribution room for each eligible individual. Your annual contribution room will be indicated on your notice of assessment.
Withdrawals, excluding qualifying transfers, made from your TFSA in the year will be added back to your TFSA contribution room at the beginning of the following year..
Excess contributions
If, at any time in a calendar month, there is an excess TFSA amount in your account, you will be subject to a tax of 1% per month on the highest excess amount, for each month that the excess remains in the account.
Non-residents of Canada
If you become a non-resident of Canada, you will be allowed to keep your TFSA and you will not be taxed on any earnings in the account or on the withdrawals.
No TFSA contribution room will accrue for any year throughout which you are a non-resident. Any withdrawals made during the period that you were a non-resident will be added back to your unused TFSA contribution room in the following year, but will only be available if you resume your residency status in Canada.
If you make contributions to your TFSA while you are a non-resident, you will be subject to a tax of 1% per month on the amount you contributed for each month, ending at the earliest of:
- when the non-resident contributions are withdrawn from the account and are designated as a withdrawal in connection with the contribution; or
- when you become resident of Canada.
Making withdrawals
You can withdraw money from the TFSA at any time and for any reason, with no tax consequence and without affecting your eligibility for federal income-tested benefits and credits.
Withdrawals, excluding qualifying transfers, made from your TFSA in the year will be added back to your TFSA contribution room at the beginning of the following year.
You cannot contribute more than your TFSA contribution room in a given year, even if you make withdrawals from the account during the year. If you do so, you will be subject to a tax of 1% of the highest amount in the month, for each month you are in an over-contribution position.
Impact on Income-tested Benefits
You can withdraw money from the TFSA at any time and for any reason, with no tax consequences and without affecting your eligibility for federal Income-tested Benefits and Credits.
Your Old Age Security (OAS) benefits, Guaranteed Income Supplement (GIS) or Employment Insurance (EI) benefits will not be reduced as a result of the income earned or the amounts withdrawn from a TFSA.
The income earned in the account or the amount withdrawn from a TFSA will also not affect your eligibility for the Canada Child Tax Benefit (CCTB), the Goods and Services Tax Credit (GSTC), the Working Income Tax Benefit (WITB), or the age credit
Death of a TFSA Holder
General rules
When the holder of a deposit or an annuity contract under a TFSA dies, the holder is considered to have received, immediately before death, an amount equal to the fair market value (FMV) of all the property held in the TFSA at the time of death.
After the holder's death, the annuity contract is considered to be a separate contract and is no longer considered as a TFSA. All earnings that accrue after the holder's death will be taxable to the beneficiaries.
Generally, amounts paid from the TFSA that represent the income earned in the TFSA after the date the holder died have to be reported by the holder's beneficiaries. These payments have to be included in the income of the beneficiaries for the year they are received.
A beneficiary will not have to pay tax on any payments made out of the TFSA that do not exceed the FMV of all the property held in the TFSA at the time of death.
Spouse or common-law partner is the sole beneficiary of the TFSA
The deceased holder is not considered to have received an amount from the TFSA at the time of death if, in the TFSA contract, the deceased holder named his or her spouse or common-law partner as the sole beneficiary of the TFSA. In this situation, the TFSA continues and the spouse or common-law partner becomes the successor holder under the plan.
If at the time of death there was an excess TFSA amount, the successor holder is deemed to have made, at the beginning of the month following the date of death, a contribution to their TFSA equal to the amount of the excess TFSA amount. If that contribution creates an excess contribution to the successor holder's TFSA, they will be subject to a 1% tax per month on the highest amount for each month they are in an overcontribution position.
If, in the TFSA contract, the holder named his or her spouse or common-law partner and someone else as beneficiaries of the TFSA, we consider that there is no successor holder. The spouse or common-law partner would be considered a survivor.
Other beneficiaries
When no spouse or common-law partner is named in the TFSA contract, the deceased holder's estate becomes entitled to receive the TFSA property. If the deceased's will states that the spouse or common-law partner is entitled to the amounts paid under the TFSA, or that the spouse or common-law partner is the sole beneficiary of the estate, the spouse or common-law partner becomes the survivor.
Under proposed changes, the TFSA that becomes a trusteed arrangement is deemed to continue to be a TFSA until the end of the exempt period, which is the end of the calendar year following the year in which the holder dies, or when the trust ceases to exist, if earlier.
All income earned during the exempt period and paid to the beneficiaries, including a survivor, will be included in their income, while earnings that accrued before death would remain exempt.
The survivor may contribute payments made within the exempt period to them from a deceased holder's TFSA into their own TFSA without affecting their unused TFSA contribution room limit. Such survivor payments become an exempt contribution.
In order for the survivor to designate an exempt contribution, the survivor must designate their survivor payments as an exempt contribution on Form RC240, Designating an Exempt Contribution to a Survivor Tax-Free Savings Account (TFSA) within 30 days after the day on which the contribution is made.
An exempt contribution cannot exceed the payment received during the exempt period and the FMV of the deceased holder's TFSA at the time of death.
Donation upon death
If a qualified donee was named as a beneficiary of the deceased holder's TFSA, the transfer of funds to the qualified donee must generally occur within the 36-month period following the holder's death.
Information provided by Canada Revenue Agency