TFSA: Mistakes & Opportunities
When managing a Tax-Free Savings Account (TFSA), many individuals make mistakes that can limit its effectiveness as a tool for saving and growing wealth. Here are some common TFSA mistakes:
1. Withdrawal or Transfer
- Withdrawals are tax-free and do not trigger any immediate tax consequences. You can withdraw any amount from your TFSA, and it will not be taxed. Withdrawing from your TFSA does not reduce the total amount of contributions you have already made for the year. Re-contributing to a TFSA in the same year as the withdrawal may result in an over-contribution and you could be subject to a penalty tax.
- A transfer does not affect your contribution room. If you want to transfer funds from one TFSA to another or from one issuer to another, there will be no tax consequences if your issuer completes a direct transfer on your behalf. However, If you withdraw the funds yourself and contribute the same funds to another TFSA, this transaction would not be considered a direct transfer and could have tax consequences.
2. Over-Contributing
- All TFSA contributions made during the year, including the replacement or re-contribution of withdrawals made from a TFSA, will count against your contribution room.
- If you decide to replace or re-contribute all or a part of your withdrawals into your TFSA in the same year, you can only do so if you have available contribution room.
At any time in the year, if you contribute more than your available TFSA contribution room you will have to pay a tax equal to 1% per month on the excess amount.
3. Successor Holder vs. Beneficiary
Choosing between a successor holder and a beneficiary for your TFSA has important implications for the future of your assets.
A successor holder allows for the continuation of the TFSA's tax advantages, and only a spouse or common-law partner can be designated as such. Upon the death of the TFSA holder, the account is transferred directly to the successor holder without triggering a tax liability or reducing the tax-free status of the account.
- The successor holder inherits the transferred TFSA’s contribution room. This means that if they are already contributing to their own TFSA, they can still contribute to their deceased partner’s TFSA without exceeding their own annual limit.
- The transfer of assets to a successor holder is often simpler and faster than dealing with a beneficiary, as the TFSA doesn’t have to be liquidated and no taxes are due upon inheritance.
A beneficiary, on the other hand, allows for the transfer of the account's proceeds but typically results in the closure of the TFSA and distribution of assets. Both options have their uses, and understanding the differences can help you make the best decision for your estate planning.
4. U.S. citizens with a TFSA
- U.S. citizens, even those living in Canada, are required to report their worldwide income to the Internal Revenue Service (IRS) each year, including any income earned in their TFSA. It's important to understand that while the account offers tax-free growth in Canada, it does not offer the same benefits in the U.S.
U.S. tax laws impose tax reporting requirements and tax liabilities on the income and growth of the TFSA. U.S. citizens should be aware of these complexities and may want to consult a cross-border tax expert to ensure compliance and optimize their savings strategy.
Summary
While the TFSA offers a wealth of benefits, it’s essential to use it wisely. By seeking professional advice, you can avoid common mistakes and set yourself up for long-term financial success. Taking the time to understand how to make the most of your TFSA, keeping track of contributions, and ensuring your investment strategy aligns with your financial goals can help you avoid these costly pitfalls and maximize the benefits of this flexible savings vehicle.
Sources: https://www.manulifeim.com/retail/ca/en/viewpoints/tax-planning/common-tfsa-mistakes