In the decade since Tax-Free Savings Accounts (TFSA) were introduced, many Canadians have welcomed this new way of sheltering their hard-earned money from tax with open arms — according to data released by the Canada Revenue Agency in 2017, there were more than 12.7 million TFSA account holders in Canada in the 2015 tax year, and nearly 17 million of these vehicles.
But simply having a TFSA and maximizing its tax efficiency over the years are two different things.
In terms of the basics, although individuals can’t deduct TFSA contributions on their income tax return, any amount they contribute, and any interest, capital gains or dividends generated, will always be tax-free – in the account, and upon withdrawal, says the government.
And anyone over 18 with a valid Social Insurance Number can have one.
All Canadians are subject to a yearly ‘contribution room’ limit within a TFSA that has fluctuated slightly since 2009. For 2017, for example, the annual TFSA dollar limit was $5,500. At the same time, individuals can carry unused contribution room to future years — someone who has never contributed to a TFSA would have $52,000 worth of contribution room as of 2017, for example.
The total amount of any withdrawals in a calendar year will be added to the TFSA contribution room for the next year.
In spite of their advantages, one problem with these vehicles, advisors say, is that not enough Canadians are maximizing their ability to deliver growth, tax efficiency or to help fund retirement.
Here are a few suggestions for getting the most out of a TFSA in 2018:
Use it to its full potential: One of the issues with a TFSA, says Pina Kitagawa, senior financial advisor at Kerr Financial Group in Toronto, is the confusion that surrounds its name.
“The fact that its called a savings account confuses [clients] and they feel like it should only be used like a bank account, it should only be cash. But it’s actually not the case. It can be the same types of holdings that you have in an RRSP,” she says.
As the government notes, TFSA-eligible investments can include cash, mutual funds, listed securities, guaranteed investment certificates (GICs), bonds and certain shares of small business corporations.
As BMO reported in its most recent annual Tax Free Savings Account (TFSA) study, nearly 80 per cent of those surveyed are aware that cash investments are eligible, while 73 per cent and 69 per cent know that mutual funds and GICs qualify.
Ultimately, those who don’t realize they can hold various investments in the TFSA aren’t earning all the income they can, says Christine White, a money coach with Money Coaches Canada, based in Whitby, Ont.
“They’re putting $50 a payday or whatever into a Tax-Free Savings Account, but that’s just going and sitting in a cash account. It’s not actually getting any compounding value, which is the whole point of being able to grow your money tax-free,” she says.
Be strategic: For individuals who have maximized their registered contributions and have enough resources available to also have a non-registered portfolio, Kitagawa says for tax optimization purposes, a TFSA or RRSP is where the more heavily taxed assets would go.
“Usually, that would be interest-generating assets like bonds or fixed income, and we’d put that in an environment where they’re not taxed or tax deferred, and then the non-registered would hold their capital gains or dividend-bearing assets.”
Go long-term: As White notes, not enough people recognize that a TFSA is probably the most tax efficient way they can save for retirement.
“If we can maximize our Tax-Free Savings Accounts and invest it in something that’s actually going to compound and grow, then it’s going to be beautiful in retirement when you can withdraw that and not have any risk of any OAS clawback or not have to pay any income tax on it,” says White.
“That would be my number one advice, try to keep it in for the long-term and let the compounding and the tax free benefit happen,” she adds.
Consider capital losses: Any losses incurred inside a tax-free savings account cannot be claimed on your tax return. If you suspect you’re going to have losses, then a TFSA is likely not the right place to hold that investment, say advisors.
“If you make an in-kind contribution to the TFSA from assets that you hold in your non-registered account, you will have to report capital gains realized on the transfer in on your tax return, whereas capital losses realized can not be claimed on your return. So that’s actually not an efficient thing to do if you hold assets in a capital loss position, as you wouldn’t get the benefit of that loss,” says Kitagawa.