A Little About TFSA's

Plan to fund your $6,000 contribution early for the largest compounding effect.

Suppose you were 18 and you had $5,500 to spare. You opened a TFSA account, then deposited the spare $5,500. By the time you reached age 65, your TFSA account will have grown to approximately $500,000. If you left the money into the account until age 73, the amount would be closer to $1 million. It almost sounds too good to be true. A different scenario: if you invested $5,500 every year until you retired, that amount would grow to approximately $5.4 million. These numbers assume the Canadian government leaves the TFSA intact over your life and that your TFSA earns an average of 9.8% each year (the average annualized total return of the S&P 500 over the past 90 years). The numbers in these two scenarios demonstrate the power of compounding and the benefits of a Tax-Free Savings account.

Compounding Compounding means you are earning money on your money earned. Say, you start with that $5,500 in year one. It makes $539. The second year you amass another $539 on the original $5,500 and another $53 on the $539. If you deposit another $5,500 at the beginning of the second year, you earn $539 on it so that by the end of the second year, you have already accumulated $12,670, assuming you do not pull any money out. So, in only two years, your $11,000 has grown by $1,670, or by 15%.

 First Year           Second Year
Opening balance                    -  $      6,039
Deposit$      5,500  $      5,500
   On first $5,500$          539  $        539
   On second $5,500                  -  $        539
     On first $539          -  $          53
Closing balance $    6,039  $  12,670

The government wants to help you out The Tax-Free Savings Account (TFSA) program began in 2009 as a way for individuals to create their retirement fund in a tax-advantaged way. With more people employed in situations where there is not a sponsored retirement fund, the government has recognized that this was a good idea.

TFSA features TFSA’s can be opened by those 18 or over with a social insurance number. While contributions to a TFSA are not deductible for tax purposes, neither is any income earned on the money invested in a TFSA taxable. Withdrawals from a TFSA will are not taxed, and when you take out money, you can put that amount back in the following year.

There are annual limits to the amount you can contribute, to date they are as follows:

Contribution Room

YearsTFSA Annual Limit                Cumulative Total
2009-12              $      5,000    $    20,000
2013-14    $      5,500    $    31,000
2015    $    10,000    $    41,000
2016-18    $      5,500    $    57,500
2019    $      6,000    $    63,500

What happens when you die? The holder of a TFSA account can designate a successor holder or beneficiary. The advantage of naming either a successor holder or beneficiary is that the assets in the TFSA can flow directly to the either without going through the estate, allowing potential savings on probate fees.

From an income tax perspective, when the holder of a TFSA dies, the fair market value of the TFSA immediately before death is considered to be received tax-free by the holder of the TFSA. The decision to designate either a successor holder or beneficiary on a TFSA doesn’t affect the tax treatment upon death but can have an impact on taxation beyond the date of death.

A Successor Holder can only be your surviving “spouse.” If you designate your spouse as the successor holder and assuming your spouse takes over the TFSA, the account continues operating as a TFSA, with a new owner.

If you designate your spouse as a Beneficiary of your TFSA, your spouse has until Dec. 31 of the year following the year of death to contribute any payments received out of your TFSA, up to the date of death value, into his or her own TFSA without affecting your spouse’s unused TFSA contribution room. Your spouse must file CRA Form RC240 within 30 days after contributing.

If you designate someone other than your spouse as the TFSA beneficiary, or you don’t name anyone at all, the TFSA proceeds go to your estate, any income earned on the TFSA assets after the date of death will, in most cases, be taxable to the beneficiary or the estate as ordinary income. A recipient who is not your spouse can only contribute proceeds from your TFSA to his or her TFSA if they have sufficient TFSA contribution room.

What experts say Many view TFSA’s like a great source of funds for unusual expenses, an emergency fund. Holding interest-earning investments is often suggested as the right thing to do because interest income is fully taxable. However, in times when interest rates are so low, this benefit erodes.

Others think you should perhaps hold equities in there that stand to grow a significant amount. Thus, even though stocks currently have a tax-preferred treatment, a significant capital gain could be realized and never taxed.

What about US equities? You are better not holding U.S.-listed equities inside a TFSA because dividends are not eligible for a credit for the withholding U.S. tax as they are when in a non-registered, taxable account. If you must put these in your TFSA, invest in TSX-listed ETFs or mutual funds that hold foreign securities.

If you are ready to go, I say, don’t wait. Get your TFSA opened as soon as you can to get started on building that tax-free nest egg.

Start saving today.