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Tax-free savings accounts (TFSAs) were first made available by the federal government in 2009. While there were some early difficulties which led to many taxpayers inadvertently breaching TFSA rules, Canadian taxpayers and their financial advisers have now become accustomed to using TFSAs as a standard part of financial, tax, and retirement planning.

A quick review of the TFSA rules: the TFSA program allows taxpayers to put up to $5,500 per year into a TFSA. No tax deduction is permitted for any contribution made, but interest or other investment income earned by the funds in a TFSA is not taxed as it is earned. Withdrawals can be made from a TFSA at any time, for any purpose, and funds withdrawn (including interest or other investment income earned) are not taxable. In addition, TFSAs are an extremely flexible savings vehicle in that the amount of any funds withdrawn from a TFSA is added to the taxpayer’s TFSA limit for the following year. So, for instance, a taxpayer who withdraws $2000 from his or her TFSA in 2014 will be able to contribute up $7,500 to that TFSA in 2015. That $7,500 is made up of the 2015 current-year contribution limit of $5,500 and $2,000 in additional contribution limit created by the withdrawal made in 2014 and carried forward to 2015.

Now that taxpayers have been able to save through TFSAs for nearly 6 years, the total amount of possible contributions (as much as $31,000, for someone who has never made a TFSA contribution) is becoming significant, as is the complexity of tracking contributions, withdrawals, and re-contributions made over the past several years. As well, it’s not uncommon for taxpayers to hold TFSAs at several different financial institutions, as those financial institutions compete for TFSA business by offering “incentive” rates of return in marketing campaigns. No matter how many TFSA accounts an individual has, the overall contribution limit for the year doesn’t change, but having multiple accounts does make it more difficult to determine where one stands in relation to that contribution limit at any given time. And, since a 1% per month penalty is assessed for any over-contributions, no taxpayer wants to find him or herself in an over-contribution position, particularly because it is completely avoidable. Like any financial or tax-planning strategy, TFSAs require regular monitoring, and right now, half-way through the current tax year, is a good time to carry out that “check-up”.

Any check on the state of one’s TFSA has to start by determining one’s current year contribution limit. The Canada Revenue Agency (CRA) used to provide that information on each taxpayer’s Notice of Assessment, but that is no longer the case. Taxpayers can obtain information on their current-year limit on the CRA website, using the Quick Access service at http://www.cra-arc.gc.ca/quickaccess/. It’s not necessary to pre-register for that service, but users will be asked for their social insurance number, date of birth, and amount entered on line 150 of their 2013 tax return. Taxpayers who have already registered for the CRA’s My Account service can log on there (http://www.cra-arc.gc.ca/myaccount/) to obtain information on their 2014 TFSA contribution limit. Finally, taxpayer-specific information on TFSA limits can be obtained by calling the Tax Information Phone Service (TIPS) line at 1-800-267-6999. Here again, the taxpayer will be asked to provide his or her social insurance number, date of birth, and the amount entered on line 150 of their 2013 tax return.

Once the 2014 contribution limit is known, it’s time to figure out just how much has been contributed to a TFSA during 2014. Many taxpayers are in the habit of depositing periodic income receipts—a income tax refund, a payment from an employer’s benefit plan, or interest income from other accounts—into a TFSA, or have arranged to have their financial institution make regular transfers from other accounts into a TFSA throughout the year. Those amounts can add up, especially where the taxpayer has multiple TFSA accounts at different financial institutions, and checking the year’s total contributions from all sources to date against total contribution room for the year is the first step to be taken, to make sure that the taxpayer isn’t already in an over-contribution position. Where that has already happened, the best course of action is to immediately transfer funds out of the TFSA to another (non-TFSA) account. Penalties payable for over-contributions to a TFSA are calculated based on the highest excess TFSA amount in each month. While a penalty will still be assessed for all months in which the taxpayer was in an over-contribution position (even if the excess contribution position only existed for one day in the particular month), withdrawing or transferring any excess amounts before the end of the current month will avoid the imposition of further penalties.

If a comparison of the contribution limit for the year to contributions to date show that there is still contribution room left for 2014, the next step would be to total up all scheduled automatic transfers which will take place during the rest of 2014 and make sure that they will not, when added to contributions that have already been made since January 1, push total contributions for the year over the allowable limit. If they will, then it’s time to make a change to the transfer schedule or transfer amounts to keep contributions within the year’s maximum allowable contribution limit.

Where there is contribution room still available for 2014, but no contributions are scheduled or anticipated, it may be time to rethink that plan. Even where one’s circumstances don’t permit the contribution of large amounts, every dollar currently sitting in other accounts which is transferred to a TFSA means less tax paid on interest or other investment income earned on those dollars. In most circumstances, there’s really no good reason not to use a TFSA to hold funds which are not needed to meet current expenses, or which are already being set aside for relatively short-term financial goals—perhaps the purchase of a new car, or next winter’s vacation. The rate of interest currently being paid on bank account balances is miniscule, and perhaps the only thing worse than receiving such meager returns is losing up to half of those already small interest amounts to income tax, when that result can be easily avoided. Having one’s financial institution transfer any “excess” funds from other accounts into a TFSA will remove the tax hit on any interest or other investment income earned on those funds. And, if a need for the funds arises unexpectedly, a tax-free withdrawal of some or all of the funds in the TFSA can always be made.

Taxpayers who are over age 71 may particularly benefit from the use of a TFSA to allow their retirement savings to continue to grow and compound on a tax-free basis. Canadians who have saved for retirement through a registered retirement savings plan (RRSP) are required, after the end of the year in which they turn 71, to withdraw a prescribed percentage of the balance in their plans each year. Where the taxpayer doesn’t need those withdrawn RRIF amounts to meet current expenses, often the best solution is to contribute those amounts to a TFSA. Income tax will still have to be paid on the required amount withdrawn, but the funds can usually be put back in the same investment vehicle from which they were withdrawn, whether that is a guaranteed investment certificate, a mutual fund, or a bond. Any future growth in the value of those investments can then compound tax-free, as they did while in the RRSP, and can eventually be received free of tax when they are withdrawn from the TFSA. And, finally, because amounts withdrawn from a TFSA are not included in income, any withdrawals from the TFSA will have no effect whatsoever on a retired taxpayer’s eligibility for means-tested benefits, like Old Age Security, the age credit, the GST/HST tax credit, or the federal Guaranteed Income Supplement.

After getting off to a slow start, TFSAs have become a standard part of financial and tax planning of most Canadian taxpayers, as there is no other savings vehicle which provides the TFSA’s combination of tax benefits and flexibility. Using TFSAs to the fullest extent possible, while taking care not to go offside with the TFSA over-contribution rules, is a win-win combination for most taxpayers.

Note: persons subject to US tax even if a resident of Canada should seek additional professional advice prior to investing in TFSAs as the US will tax the income from those accounts even though Canada will not under the current tax treaty between the two countries.

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