You may contribute up to the annual maximum in a Tax-Free Savings Account (TFSA) until Dec. 31 each year.
There is no “grace” period of 60 days into the New Year to make contributions for the year, as there is with RRSPs. So that gets a lot of people wondering about TFSA contributions and withdrawals in the same year. And it’s here that many people run afoul of the rules for TFSAs, with consequent surprise tax penalties you may be unaware of.
A TFSA, remember, lets you contribute a maximum $5,500 annually, regardless of your income or pension plan or anything else. You have to be over 18 and a have a valid Canadian Social Insurance Number. That’s it.
In addition, if you don’t contribute to your TFSA in a given year, you may carry that unused “contribution room” forward to be used in future years to use above and beyond maximum contributions.
There’s no tax deduction for contributions, but the whole beauty of the TFSA is that investment income generated within the plan—whether interest, dividends, or capital gains—is completely tax-free.
TFSAs were started by the federal government in 2009, and if they’re not the best thing in personal financial sliced bread since RRSPs debuted back in 1957, I don’t know what is.
Don’t Dip into a TFSA
The major alluring feature of the TFSA is that any withdrawals are completely tax-free too. The point is that you’re contributing to your TFSA in after-tax dollars—so you’ve already paid tax on the income. But it can be far too easy to start looking at your TFSA as a plump, juicy apple, ready for the picking whenever you need it.Yes, it’s true, withdrawals can be made from a TFSA at any time, and, yes, they are tax-free. But a couple of things happen when you do this. First, you immediately start to lose the benefits of all that tax-free compound growth. If you crack open the TFSA piggy-bank before you’ve achieved your savings objective, whether it’s 3, 5, 10, or 35 years, you’ll be back to square one in terms of investment returns.
Monthly Tax Penalty Has No Wiggle Room
According to the Canada Revenue Agency, there is a tax of 1 percent per month that is based on the highest excess TFSA amount in your account for each month in which an excess exists. This means that the 1 percent tax applies for a particular month even if an excess amount was contributed and withdrawn later during the same month.The excess-amount tax is like the 1 percent per month tax levied on excess RRSP contributions with one crucial—and potentially costly—difference: There is no $2,000 “grace” amount, and the excess-amount TFSA tax kicks in on the first dollar of excess contributions. Ouch!
The whole business of “excess amounts,” “qualifying portion of withdrawals,” and “exempt contributions” can make your head spin—and can shrink your bank account if you trip over the rules. (More information is available at the CRA website.)
So be sure to check with a financial planner before you start using your TFSA as an everyday savings account. Generally, it’s just better to consider your TFSA as a special, registered tax-sheltered investment vehicle with some lucrative tax benefits, rather than as an everyday account for spending money.
