The Tax-Free Savings Account (TFSA) may have celebrated its fifth anniversary at the beginning of the year, but a lot of Canadians are still confused about its rules. Not since RRSPs (Registered Retirement Savings Plan) has there been such a powerful way to save. The TFSA is great savings vehicle, as long as you follow the rules. Over contributing to your TFSA can result in costly penalties.
TFSA Withdrawal Rules Tripping up Canadians
Have you withdrawn money from your TFSA this year? It’s important to keep track of any money you take out of your TFSA – the last thing you want is to re-contribute money too soon and face a penalty. According to Canada Revenue Agency (CA), 54,700 taxpayers received warning packages for not following the TFSA rules in 2013. Although this is down from a record 103,000 in 2010, it still shows far too many Canadians misunderstand TFSA rules. If you need a refresher on the TFSA rules, the Tax-Free Savings Account (TFSA), Guide for Individuals is worth checking out.
Unlike your RRSP, your withdrawals aren’t slapped with withholding taxes. The only thing you forgo is the tax-free growth. You’re free to withdraw your money as you see fit. The rules on TFSA are pretty clear – you can only re-contribute withdrawn money on or after January 1st of the following year. However, if you have unused TFSA contribution room from previous years, you’re free to contribute in the same year as long as you have sufficient room.
The easiest way to avoid over contributing is to keep track of your TFSA withdrawals yourself. A simple spreadsheet in Microsoft Excel will suffice. Although CRA has a Quick Access Tool for checking your TFSA contribution room, it isn’t the most reliable since it’s not necessarily up to date. As Young and Thrifty suggests, if you’re unsure about your TFSA contribution limit, you’re better off calling CRA’s toll-free number (1-800-959-8281) and requesting your TFSA Transaction Summary.
Transferring Your TFSA to Another Financial Institution
There are ways you can avoid over-contributing to your TFSA. If you’d like to transfer your TFSA from one financial institution to another, there will be no tax consequences, as long as your issuer completes a direct transfer on your behalf. Each financial institution has its own direct transfer form. You’ll want to complete a direct transfer form with the financial institution you’re transferring the funds to. For example, if you’re transferring your TFSA from PC Financial to Tangerine, you’ll want to complete a direct transfer form from Tangerine.
Financial institutions often offer teaser rates around January 1st to entice you to sign up with them. Before you sign up, it’s important to find out if there’s a transfer out fee. More often than not, financial institutions will charge you a fee for transferring out your TFSA. Sometimes the receiving institution will cover the fee, so if you’re thinking of parking your money somewhere else, don’t be shy to ask.
A teaser rate is as the name suggests – it’s a high rate that usually drops after a limited time. For example, you could receive 3% on your TFSA for the first three months before the rate drops to 1% for the remaining nine months of the year. You should take the time to review a financial institution’s history to see if it has a habit of dropping its rates. Although you may be able to transfer your account, it can sometimes take a couple months for your funds to move out. The easiest way to avoid the headache of a direct transfer is to simply withdraw your money at the end of December and contribute it at another financial institution on or after January 1st of the following year.
TFSA or RRSP
A lot of Canadians face a similar dilemma – should I invest in my RRSP or TFSA? In a perfect we’d contribute the maximum amount to both each year. Unfortunately, that isn’t always possible, especially if you have a hefty mortgage.
If you’re earning an income of $50,000 or more, you’re probably better off contributing to your RRSP. If you’re just starting out your career and you’re saving towards a major purchase like a home, the TFSA can help you get there sooner.
Investing in a TFSA or RRSP comes down to your personal financial situation. The RRSP assumes income tax rates will be similar to what they are today, but what if they’re a lot higher? As the saying goes, you shouldn’t put all your eggs in one basket. To be on the safe side, you might consider contributing to both. Instead of contributing $400 to your RRSP, split it evenly by contributing $200 to your TFSA and $200 to your RRSP.
Have you ever made the mistake of over contributing to your TFSA?
Sean Cooper is the bestselling author of the book, Burn Your Mortgage: The Simple, Powerful Path to Financial Freedom for Canadians, available now on Amazon and at Chapters, Indigo and major bookstores, and as an Audiobook on Amazon, Audible and iTunes.