Put that $6,000 of TFSA contribution for 2020 to work as soon as possible

The federal government kept the annual TFSA contribution limit at $6,000 for 2020 – the same annual TFSA limit that we had in 2019. It’s good news for Canadian savers and investors, who as of January 1, 2020, have a cumulative lifetime TFSA contribution limit of $69,500.

The Tax Free Savings Account (TFSA) was introduced in 2009 by the federal conservative government. The TFSA limit started at $5,000 that year: an amount that “will be indexed to inflation and rounded to the nearest $500.”

TFSA Contribution Limit Since 2009

The table below shows the year-by-year historical TFSA contribution limits since 2009.

Note that the maximum lifetime TFSA limit of $69,500 applies only to those who were 18 or older on January 1, 2009. If you were born after 1991 then your lifetime TFSA contribution limit begins the year you turned 18.

You can find your TFSA contribution room information online at CRA My Account, or by calling Tax Information Phone Service (TIPS) at 1-800-267-6999.

TFSA Overview

The Tax Free Savings Account is a flexible vehicle for Canadians to save for a variety of goals. You can contribute every year as long as you’re 18 or older and have a valid social insurance number.

That means young savers can use their TFSA contribution room to establish an emergency fund or save for a down payment on a home. Long-term investors can use their TFSA to invest in ETFs, stocks, or mutual funds and save for the future. Retirees can continue to save inside their TFSA for future consumption or withdraw from their TFSA tax-free without impacting their Old Age Security or GIS.

Unlike an RRSP, any amount contributed to your TFSA is not tax deductible and so it does not reduce your net income for tax purposes.

• You can contribute room is capped at your TFSA limit. Excess contributions will be taxed at 1 per cent per month
• Any withdrawals will be added back to your TFSA contribution room at the start of the next calendar year
• You can replace the amount of your withdrawal in the same year only if you have available TFSA contribution room
• Any income earned in the account, such as interest, dividends, or capital gains is tax-free upon withdrawal

How to Open a TFSA

Any Canadian 18 or older can open a TFSA. You are allowed to have more than one TFSA account open at any given time, but the total amount you contribute to all of your TFSA accounts cannot exceed your available TFSA contribution room.

To open a TFSA you can contact any bank, credit union, insurance company, trust company or robo-advisor and provide that issuer with your social insurance number and date of birth.

The most common type of TFSA offered is a deposit account such as a high interest savings account or a GIC.

You can also open a self-directed TFSA account where you can build and manage your own savings and investments.

Qualified TFSA Investments

That’s right: you’re not just limited to savings accounts and GICs. Generally, you can put the same investments in your TFSA as you can inside your RRSP. These types of allowable investments include:

• Cash
• GICs
• Mutual funds
• Stocks
• Exchange-Traded Funds (ETFs)
• Bonds

You can contribute foreign currency such as USD to your TFSA. Note that your issuer will convert the funds to Canadian dollars. The total amount of your contribution, in Canadian dollars, cannot exceed your TFSA contribution room.

If you receive dividend income from a foreign country inside your TFSA, the dividend income could be subject to foreign withholding tax.

Gains inside your TFSA

Some investors may be tempted to put risky assets inside their TFSA account to try and earn tax-free capital gains. There are two advantages to this strategy:

1. Earn tax-free capital gains
2. Potentially increase your available TFSA contribution room

For example, I maxed out my annual TFSA contributions in 2009, 2010, and 2011. That meant contributions of $15,000. I invested these funds in dividend-paying stocks, which, over time, increased the total portfolio value to $19,500.

I withdrew the entire amount in mid-2011 to top-up the down payment on our new house. When the calendar turned to 2012, I had a new lifetime TFSA contribution limit of $24,500.

How did I have $24,500 in unused TFSA contribution room available even though most other Canadians had $20,000?

Any TFSA withdrawals are added back to your available TFSA contribution room at the beginning of the next calendar year. That amount was $19,500. In addition, the 2012 TFSA limit of $5,000 was added to my overall TFSA contribution room for a total of $24,500.

Losses inside your TFSA

The risk cuts both ways, though.

Let’s say the dividend stock picks inside my TFSA incurred a loss of $4,500. I contributed $15,000 but they’re only worth $10,500 when I need to withdraw the money for my house down payment.

The next calendar year, after I withdrew the funds, I would have only saw $10,500 added back to my TFSA contribution limit, plus the new 2012-dollar limit of $5,000: for a total TFSA limit of $15,500.

The other downside to an investment losing money inside your TFSA is that you cannot claim a capital loss.

“In kind” TFSA Contributions

You can make “in kind” contributions to your TFSA: for example transferring stocks or funds held in your non-registered account to your TFSA.

According to the CRA, you will be considered to have disposed of the security at its fair market value at the time of the contribution. If that value is more than the original cost of the security, you will have to report the capital gain on your income tax return. However, if the value is less than the original cost, you cannot claim the resulting capital loss.

The amount of the contribution to your TFSA will be equal to the fair market value of the property.

This can be an excellent strategy for seniors and retirees to transfer securities from their taxable investment account and into their sheltered “tax-free” TFSA.

Transfer from your RRSP

You can also transfer an investment from your RRSP to your TFSA. Again, according to the CRA, you will be considered to have withdrawn the investment from the RRSP at its fair market value.

This amount is reported as an RRSP withdrawal and must be included in your income for that tax year.

“The tax withheld on the withdrawal can be claimed at line 437 of your income tax and benefit return.”

If the transfer from your RRSP to TFSA takes place immediately, the same value will be used as the amount of the contribution to the TFSA. If the contribution is delayed or deferred, the amount of the contribution will be the fair market value of the investment at the time of that contribution.

TFSA Over-Contribution Penalty

Unlike the RRSP Over-Contribution limit of $2,000, TFSAs have no such room for error.

Some Canadians have run afoul of the CRA for over-contributing to their TFSA. The excess contributions are subject to a 1 percent penalty tax per month. For example, if you’ve over-contributed $1,000 you would have to pay $10 per month.

If you receive a TFSA excess amount letter from the CRA you should remove the excess amount immediately. Go to CRA My Account for your room limit as of January 1, or complete Form RC343, Worksheet – TFSA contribution room if you have contributed to your TFSA in the current year.

TFSA Impact on Government Benefits

The TFSA has been a tremendous boon for seniors and retirees. The main advantage is that any income earned inside your TFSA, or amounts you withdraw from your TFSA, won’t impact means-tested government benefits such as Old Age Security (OAS) and the Guaranteed Income Supplement (GIS).

That means retirees could get a portion of their retirement income from their TFSA and not have that amount increase their total net income. This is beneficial to either preserve GIS benefits or to avoid the dreaded OAS clawback.

TFSA income or withdrawals will also not affect employment insurance benefits, or your eligibility for other credits such as the Canada child benefit (CCB), the working income tax benefit (WITB), the GST credit, or the age amount.

TFSA Beneficiaries and Death of TFSA Holder

There are two types of TFSA beneficiaries:

1. A survivor who has been designated as a successor holder
2. Designated beneficiaries, such as a survivor who has not been named successor holder, a former spouse or common-law partner, children, and qualified donees

A successor holder is a spouse or common-law partner of the holder at the time of death and is named by the deceased as the successor holder of the TFSA.

The successor holder acquires all of the rights of the holder, including the right to revoke any beneficiary designation. This spouse or common-law partner becomes the new TFSA account holder.

The TFSA continues to exist and both its value at the date of the original holder’s death and any income earned after that date continue to be sheltered from tax under the new successor holder.

The successor holder can make tax-free withdrawals from the deceased holder’s TFSA account. He or she can also make new contributions to that account, subject to their own unused TFSA contribution room.

Investing Ideas for your TFSA

The TFSA is an incredible savings tool. Low income earners should primarily use their TFSA to save for retirement, while higher income earners should maximize their RRSP contributions first, but ideally contribute to both their RRSP and TFSA.

Related: A Sensible RRSP vs. TFSA Comparison

Here are my recommendations for the best TFSA investments for long term savers:

Invest with a Robo Advisor: Robo-advisors offer Canadians an easy and hands-off way to automatically invest for the future. Open a TFSA at a robo-advisor like Wealthsimple and you can invest in a diversified portfolio of index ETFs for a management fee of 0.50 per cent, plus the MER of the ETFs, for a total cost of about 0.70 per cent.

DIY Invest with ETFs: Investors who are more inclined to take the wheel themselves can open a self-directed TFSA account at a discount broker like Questrade and build their own investment portfolio. With the introduction of one-ticket asset allocation ETFs from the likes of Vanguard, iShares, and BMO, it’s never been easier to build a globally diversified portfolio on the cheap. Vanguard’s VBAL, for example, represents the classic 60/40 balanced portfolio and comes with a MER of just 0.25 per cent.

Invest in bank index funds: Maybe you’re more comfortable staying at your home bank and investing through an advisor. Know that every bank offers its own suite of index funds, which are considerably cheaper than their actively managed cousins and tend to outperform. Open a TFSA account at your bank and insist on getting a portfolio of index funds. TD’s popular e-Series funds are the most highly rated and lowest cost of the bunch and will cost around 0.45 per cent. Expect the other banks’ index funds to cost closer to 1 per cent.

In addition to running the Boomer & Echo website, Robb Engen is a fee-only financial planner. This article originally ran on his site on Dec. 19, 2019 and is republished here with his permission.