Tuesday, 9 December 2014

The TFSA and Why I Use It

    The Tax Free Savings Account (TFSA) is a relatively new form of registered account for Canadian's to utilize for investing and tax minimization purposes. Made available at the start of 2009, the TFSA allows eligible Canadian residents (18+) to invest their hard earned money tax free! Well, mostly anyways as there are some rules and qualifications to look out for.
    Some quick stats on the TFSA:

The Good Stuff:
- No taxes upon withdrawal of funds.
- No taxes on eligible dividends.
- No taxes on eligible capital gains.
- Cumulative contribution room.
- Once money is withdrawn, contribution room is returned the next year.
- For retirees, money withdrawn does not count against OAS calculations.

The Tricky Stuff:
- Accidentally holding non-eligible investments erases the benefit of the account(Ex. U.S. Stocks).
- Going over the contribution limit means a penalty of 1% of the value over-contributed per month.
- Finding out if a particular investment is eligible or not is not always simple.

My use of the TFSA:
    Currently my entire portfolio is held within what would be called a self-directed TFSA, since I am personally overseeing the buying and selling of all the financial instruments held within my portfolio. If a financial adviser or manager where to be doing the investing for me it would be a directed-TFSA, either way does not make a difference to the benefits. As a young investor the major, long term benefit for me is that all my dividends and distributions that I receive from the shares that I hold on to are going to be 100% tax free, for life! Even though dividends are very tax efficient, especially Canadian company dividends as they receive an additional tax break, 100% tax free is even better! Additionally, capital gains which are normally taxed at 50% are completely sheltered as well. The only major downside is that if I were to sell an investment at a loss, then I cannot claim and use any of the capital losses to offset any capital gains taxes. For the foreseeable future the TFSA is likely to be my only account until I max out the contribution room, which at my current rate might take awhile.

TFSA Eligible Investments:

    When looking at the Canada Revenue Agency's (CRA) website for TFSA's they list the following as eligible investments:
- Cash
- Mutual funds
- Securities listed on a designated stock exchange
- Guaranteed Investment Certificates (GIC's)
- Bonds
- Certain shares of small business corporations

TFSA Limits and Common Uses:

  The current limit of money that anyone can put into the account if they were 18 or older when the TFSA was created is $31,000. In 2015 the limit will have an additional $5,500 added to it. However, say you turned 18 in 2014, you would have a limit of $5,500 only, and then in 2015 when the next $5,500 is added you would then have a TFSA limit of $11,000. Nicely enough any unused contribution room is carried forward into the following calendar year and is not lost if not used.

(Note, after writing the article the 2015 limit was increased to $10,000. 2016 limit was lowered back to $5,500 by the new government. So total limits are now higher by $4,500)

    The contribution limit is set to an individual on a whole and not any single account and refers to the money placed INTO any TFSA. Which means I cannot open up multiple accounts and expect to put in $31,000 into each without getting hit with a massive over-contribution penalty(1% fine of the value above the limit per month!). So for example you have an account with Questrade where you put in $10,000, another TFSA account with your Bank worth $20,000, you would then still have contribution room to say, buy $1,000 worth of the Royal Bank of Canada with Computershare. Once money is placed into a TFSA you cannot reclaim the contribution room when you take the money out until the next calendar year. So on January 1st of the next year you would then have the amount of money withdrawn out of a TFSA in 2014, plus the new amount of contribution limit added for the year.

     Due to the inability to use losses to offset capital gains, the TFSA is a perfect investment vehicle for core holdings, those blue chip companies which you intend to hold onto for a very long time and collect dividend payments. Alternatively, if you are an aggressive trader and believe in your stock picking ability then the allure of tax free capital gains on speculative stocks can also be very lucrative. But that also means an inherently greater amount of risk, compounded by the not being able to use any of the losses to offset gains in non-registered accounts.
    By no means is this an exhaustive list/explanation of a TFSA, but hopefully helps to outline and describe some of its common uses and pitfalls. As I find out more and time allows I'll try and post a Part 2. There is also some concerns popping up in news articles about the Canadian Revenue Agency (CRA) going after individuals who are earning too much and are being classified as business accounts due to frequent trading.


  1. Good overview, DW. I love TFSA. We get taxed at every step of the way...so, a taxbreak is a breath of fresh air.


    1. Thanks. Yeah its a big help to those who know a bit of how to use it and don't speculate when they shouldn't. Its just a shame so many people just park their cash there, although for shorter term deposits(6mo-1yr) and if you have no other ability to save, might as well avoid a little bit more income tax. Long term though, the fact it doesn't take away from OAS payments I think will make it a very power retirement investment tool. Hopefully the CRA doesn't change it. As a young guy starting out, I love the idea of its potential for me.

  2. Anytime you can get a tax break take it. This is similar to IRA or ROTH accounts in the U.S. I have both a taxable account and a ROTH. My Canadian banks are in my ROTH as there is no withholding tax for U.S. citizens holding Canadian stocks in retirement accounts. Thanks for sharing.

    1. Agreed DivHut, legally dodging those taxes is pretty nice ;) TFSA is similar to the American ones, however as I mentioned its not quite the same and its also fairly new so there isn't treaty coverage yet between US/CA for this account, so no US stocks for me in there. Our RRSP/RESP however are both perfectly good spots for US stocks to be placed without getting taxed :) One of these days I'll be able to happily announce a new post of Opening my RRSP and DW Buy's America!