How Well Do You Know TFSAs?
Posted by Gail | Filed under Investing
It’s not a difficult product to understand, yet there are already all kinds of misconceptions growing up around Tax Free Savings Accounts. Hey, I guess I shouldn’t be surprised. RRSPs have been around since Moses was in shorts and people still don’t know the most basic rules. Wanna see whether you should head back to school on TFSAs. Ranking the following True or False, let’s see how many of these you get right:
1. You can contribute up to $5,000 a year to a TFSA and if you miss a year, you lose that contribution room.
2. As with an RRSP, the interest on your TFSA is tax-deferred.
3. If you take money out of your TFSA you can put it back at any time.
4. A TFSA is a better way to save for a downpayment on a home than an RRSP.
5. Contributions to a TFSA are tax deductible.
6. TFSA can only hold investments that generate interest income.
7. You can only have one TFSA at a time.
8. Putting money in a TFSA for your spouse reduces your contribution amount for the year by the same amount.
9. You can transfer money directly from your RRSP to your TFSA.
10. TFSA beat RRSPs hands down as a way to save for the future.
11. Any Canadian with money to save can open up a TFSA.
12. If I borrow to invest in stocks inside my TFSA, I can deduct the interest on the investment loan on my tax return.
Add up your Trues and your Falses and let’s see how you did…
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1. You can contribute up to $5,000 a year to a TFSA and if you miss a year, you lose that contribution room.
FALSE. While the contribution limit is $5,000 currently, you don’t lose your contribution room if you fail to make a contribution.
2. As with an RRSP, the interest on your TFSA is tax-deferred.
FALSE. All income earned in a TFSA is tax free.
3. If you take money out of your TFSA you can put it back at any time.
FALSE. You can’t put the amount withdrawn back until the next calendar year. If you try and you’ve already reached your limit for the year you’ll be hit with an over-contribution penalty. There are loads of people who haven’t figured out this rule who will pay dearly. The government seems willing to allow for first year ignorance, but that won’t last long.
4. A TFSA is a better way to save for a downpayment on a home than an RRSP.
FALSE. Since an RRSP comes with higher contribution limits, depending on your income, you could be able to save more quickly using an RRSP and the Home Buyers’ Plan than you could with a TFSA. Of course, you’d then have to pay the RRSP back, but only at a rate of 1/15 of the amount borrowed each year.
5. Contributions to a TFSA are tax deductible.
FALSE. Nope.
6. TFSA can only hold investments that generate interest income.
FALSE. A huge range of investment options are available within a TFSA including stocks, bonds, and mutual funds. In fact, a TFSA can hold anything an RRSP can hold.
7. You can only have one TFSA at a time.
FALSE. You can have as many of these puppies as you’d like, but you can’t go over the annual contribution limit.
8. Putting money in a TFSA for your spouse reduces your contribution amount for the year by the same amount.
FALSE. Contributing to a spouse’s TFSA will not affect your own contribution room. Income attribution rules, which currently apply to RRSPs, do not apply to TFSAs.
9. You can transfer money directly from your RRSP to your TFSA.
FALSE. If only. That would let you avoid the tax hit on RRSP withdrawals. Wouldn’t that be sweet?
10. TFSA beat RRSPs hands down as a way to save for the future.
FALSE. Hey, as with everything about money, there are no hard and fast rules about what will work best. If you’re in a low income tax bracket, a TFSA may be better for you. Ditto if you’ve got a great pension plan at work. But if you’re young, earning good money, and looking for a way to build retirement savings, an RRSP may still be your best bet for saving on taxes now, and growing your money for the future.
11. Any Canadian with money to save can open up a TFSA.
FALSE. Unlike an RRSP where you just have to have earned some income, with a TFSA you have to be 18 years old to open up a plan.
12. If I borrow to invest in stocks inside my TFSA, I can deduct the interest on the investment loan on my tax return.
FALSE. Interest expenses related to a loan for investments held in a TFSA are NOT tax-deductible.
August 18, 2010 at 6:17 am
In regards to Number 10, according to Gordon Pape’s book on the TFSA (Called Tax-Free Savings Accounts) When he compares RRSPs to TFSA the only time a TFSA is beats a RRSP is when your tax rate in retirement is higher then when you made contributions.
An RRSP for most people is the still the best way to save for retirement.
regards,
Jason
August 18, 2010 at 7:34 am
@Jason If we’re talking either/or I agree that the RRSP is usually the best bet, but it could be really useful to have some TFSA money available during retirement that you can remove without worrying about the tax implications. I think they’re a great addition to a retirement portfolio.
August 18, 2010 at 7:39 am
Great blog once again! It’s amazing that some ppl still don’t know the value of TFSAs! I’ve been trying to convince some of my friends to open one. Tax free savings!And you can access the money when you need it, with no penalty.
ING’s interest rate right now is 2% which makes me happy!
August 18, 2010 at 7:40 am
Yeah! I got them all right! Woo-hoo!
But, for me, having a TFSA is just a motivator to build my EF, just because I want to max out the $5000 limit per year. At this stage of the game, I don’t see much more benefit than a regular savings account, other than that, and the fact that, because it’s with ING, a lot harder to access the money. There is a higher interest rate as well, but it’s still not a LOT of money at this point in my savings plan. Yeah, I’d never see $40 interest in 6 months with Scotia or whatever, but $40 isn’t going to make or break me either.
August 18, 2010 at 8:04 am
A little off-topic, but being as we’re talking saving money…
what do people think of the new ING Thrive account?
August 18, 2010 at 8:14 am
Cas, I think it is a great idea, although I’m not quite through checking it out before opening one.
ING absolutely sold me on their way of doing busines when I opened my TFSA with them last year. I am using it for my emergency fund. When I had to take some out for an emergency and then was later building it back up the next year, I couldn’t figure out why at one point, it wouldn’t let me contribute any more money. I called them and found out that they put a self-cap on every TFSA account so that you could not contribute more than $5000 per year. So everyone with a TFSA with them escaped the headache this year of those who over-contributed. I find it disappointing though that the the government is not enforcing the penalty because it’s just another example of how people who don’t follow the rules don’t have to be accountable.
August 18, 2010 at 8:18 am
Yep, got them all right…whew, good thing since I open them everyday for my clients…LOL…there are alot of misconceptions about this account…I guess for some it really does seem too good to be true…lol…that 5k per year if maxed out will start to really add up and the tax savings will be great…especially if you open up a TFSA brokerage account and you hit the right stock…( I have seen it)…also, about the TFSA vs the RRSP…with me being able to claim the disability tax credit for both my husband and my son there is no benefit at all to an rrsp for me…so the TFSA is the way to go since I don’t have to pay any tax on the money when I withdraw it…if I needed the rrsp contribution to lessen the tax I pay I would continue on and if that ever changes I will go back to rrsp but for now there is no benefit whatsoever as the contributions doing nothing for me tax wise and I would have to pay tax on any withdrawals…TFSA is a great vehicle and we should all take advantage of it if we can…
Hey, the code at the bottom has been moved…kudos for that AND I can read it easy peasy…yaaayyy!!!!!!!
August 18, 2010 at 8:29 am
That ING Thrive account is going to shake up the competiotion. This is good. I personally wont benefit from it as I have no fee chequing account at two other FI’s. One is the National Bank All-In-One HELOC/chequing account where I do all of my banking, and also from my employer which I dont use much. I use the ING 2% TFSA as my EF primarily.
August 18, 2010 at 8:33 am
Here is info about the ING Thrive account, for your reference:
http://www.ingdirect.ca/en/chequing/index.html
0.25% interest on chequing account for $0-$49,999 balances …
deposit or withdraw for free nation-wide through THE EXCHANGE® Network.
Online Daily Banking FREE
Email Money Transfers FREE
ABM Deposits / Withdrawals (THE EXCHANGE® Network) FREE
Online Statements FREE
Bill Payments FREE
Point of Sale FREE
View Cheque Image Online FREE
First Cheque Book (20 Cheques) FREE
Additional Cheque Book (20 Cheques) $10
Whoops! Protection FREE
Whoops! Late Fee (after 30 days) $2.50 every 30 days
Stop Payment 1 FREE per year – $10
Replacement Client Card 1 FREE per year – $15
Canadian Drafts (includes courier) $10
NSF (Non-Sufficient Funds) $25
August 18, 2010 at 8:50 am
I managed to answer all the questions correctly. We have gone over the pros & cons of TFSA’s in our Gail Club a couple of times, which was helpful to get my questions answered when someone wasn’t trying to sell me something, lol!
I opened my first TFSA account only this year and have been contributing monthly. This is my EF so I have no intention of taking money out of this account unless it’s truly necessary.
August 18, 2010 at 8:58 am
Ugh! I got 5 wrong, fortunatly many would not apply to me – I don’t plan on borrowing money from my TFSA to invest, I wouldn’t contribute to my spouses TFSA right now, and I’m 18! otherwise I am pretty happy with my TFSA (albeit small).
August 18, 2010 at 9:20 am
I’m actually surprised I got them all right! I have not read much of anything on TFSAs, but the answers were all straight forward. I am looking to open my own TFSA within the next few months.
A wonderful post. Thanks for continuing to explain financial jargon and clearing up misconceptions many of the population have about money. I look forward to reading your posts daily.
August 18, 2010 at 10:28 am
Some people say that the RRSP is a better choice for retirement savings unless your tax rate in retirement is higher than when you made the contribution. This isn’t exactly true. If your tax rate is the same at contribution and retirement, the TFSA is a better choice. Here’s why:
With the TFSA, you claim the income as taxable in your early years. With the RRSP, you claim the income as taxable during retirement. If your tax rates are the same at both times, these two options work out to be perfectly equal. However, starting at age 65, you may be eligible for Old Age Security (OAS) payments. The amount of OAS you are eligible for is dependent on your income. Therefore, although the RRSP and TFSA produced exactly the same return, RRSP withdrawals count as income in those retirement years and could reduce the amount of OAS you receive.
Also, if you still have substantial RRSP savings when you die, it counts as if you withdrew the whole remaining balance in your final year of life, which might push you into a higher tax bracket than when you contributed the funds. This leaves your estate with a higher tax bill than if you had used the TFSA.
August 18, 2010 at 10:34 am
Correct me if I am wrong ( as I don’t have a TSFA yet), but when people put money into a TFSA they can choose whether it is going to be invested in stocks/bonds/dividends like RRSP or a savings account with interest???
What choices does one have when they go to sign up at the bank? Which is the most popular choice?
August 18, 2010 at 10:43 am
Gail – this is off topic, but I saw on your guestbook that someone was asking about virtual jars for mobile phones. I’d love to have them if they were ever available!
August 18, 2010 at 10:50 am
I don’t feel that it’s a question of RRSP or TFSA. It should be both. I put my $5000 into my TFSA the first week of January, and put my RRSP contribution for the year in as soon as I found out for sure what I was allowed on my income tax return.
This way I get the maximum return on the year’s contributions.
August 18, 2010 at 11:48 am
I also have been trying to convince (inform) my friends of the value of TFSA but alas it falls on deaf ears. I think it has to do with the fact that people really don’t know, that like a RRSP, it is really an umbrella account where you can hold any type of investment – it is not simply a ‘savings’ account, although most individuals tend to use it as their emergency fund.
For those of us older folks, wish it could be ‘grandfathered’ such that we could get back those 20-30years of contribution room. Seriously, how many of us have that kinda cash on hand to take of advantage of it? But since of lot of baby boomers and soon-to-be-retirees took such a huge hit with the financial meltdown, this could be a way to try to at least make up some of those losses on a tax-free basis (although it still depends on your investment choice(s)). If you’re 18 now – jump all over this investing vehicle – you’ll be golden.
I do both – but think at this stage for me, the TSFA will get funded ahead of the RRSP. Tax-free trumps tax-deferred based on my age and years left to retire. I dollar-cost-average through my group RRSP at work, so I can easily increase (decrease) my contribution amount beyond 5% to get my company match. So at the end of the day, the minimum I contribute to my RRSP is 5% to get the maximum company match.
August 18, 2010 at 11:55 am
You missed something on your response to #11: Any Canadian with money to save can open up a TFSA.
You have to be 18 years old, but you also have to be a Canadian resident to contribute to a TFSA. The residency rule also applies for contributions to RRSPs. In a year, you are allowed to contribute to a TFSA until the point at which you cease to be a resident.
August 18, 2010 at 1:19 pm
I was beginning to wonder about my answers when they were all false, but hey, apparently I was on the right track! Thanks for clarifying all these issues. For those saving their EF in a TFSA, are you concerned about losing your contribution room if you have to pull it out for an emergency? That’s the only thing that has stood in my way so far. Probably a minor issue-if you’re having a real emergency, lost contribution room woudl be the least of my worries, but “touch wood” we don’t have any major emergencies, the money would grow tax-free…..hmmm….seems like I’m talking myself into it now. Am I missing anything?
August 18, 2010 at 1:26 pm
@psychsarah: But you get your contribution room back the following year… and it would probably take a bit to build it back up again anyway, so I don’t see the problem… For example: Let’s assume I have $5000 in a TFSA, and I needed $2000 for a car repair in June. In January of the following year, I now can put that $2000 back, plus have $5000 more available in contribution room due to the new year. Yes, if I got a bonus of $2000 in September, I’d have to wait until January, but it’s not a huge loss. I expect most people would need some time to build it back up anyways, or they wouldn’t be ‘borrowing’ from it to begin with.
August 18, 2010 at 1:28 pm
thank you for the clarification. Because of the lousy interest rates and my low income bracket, I was not interested in opening a TFSA at all. Then I was given some money to hang on to for my son’s tutoring costs by Grandpa. I wanted it to do a little more than a regular account, I opened the TFSA savings account at my Credit Union… still diddly squat for interest, but at least it’s a start.
August 18, 2010 at 1:35 pm
@*pol — ING is currently double the interest that my CU is offering (ING: 2%, CU: 1%). Just something to think about.
August 18, 2010 at 1:51 pm
Great article! And I’m pleased to say that I got them all right:)
My question is in regards to filing my income taxes. How do I ‘claim’ the contributions to my TFSA? Or, does the bank take care of that for me and I don’t need to worry about it.
Thanks
August 18, 2010 at 2:13 pm
Can you have both a TFSA and an RRSP and thereby take advantage of both maximum contribution limits?
August 18, 2010 at 2:17 pm
TFSA at ING gives you practically no interest – what is it right now, like 1.3%? It’s better to set it up with a discount brokerage (I use Credential Direct) where you can hold equities, GICS, Bonds etc and make more interest that is tax free. This is a great tax free vehicle – I have both an RRSP and TFSA – with both I’m avoiding paying tax on income earned from interest, captial gains, and dividends. Right now my TFSA has a blue-chip dividend paying stock in it and I’m planning on using to buy another. Why get only get a few dollars in interest per month with ING when every 4 months I get $40 in dividends from one stock – also if I sell the stock higher than when I bought it there is no capital gains incurred! Inflation will eat any interest you get just keeping it in a savings account like ING – trust me, I had an ING TFSA and transferred when I learned I was under-utilizing it.
August 18, 2010 at 2:19 pm
Marie Says: Can you have both a TFSA and an RRSP and thereby take advantage of both maximum contribution limits?
Answer: Absolutely! One does not affect the other in terms of being able to contribute to both or either, except for what your budget allows.
August 18, 2010 at 2:54 pm
@Jolie…the TFSA is available in all investment vehicles…savings account, gic’s, mutual funds and brokerage accounts…there’s a choice for everyone
August 18, 2010 at 2:55 pm
@ LeAnne…because a TFSA is a registered account CRA has your info in terms of what you have contributed, what you’ve withdrawn and what your contribution room is for the next year…it shows up on your notice of assessment just like your RSP contribution info
August 18, 2010 at 4:42 pm
I’m continuously surprised to hear about how so many people are confused about TFSAs. To me, the TFSA is the best thing to be introduced for Canadians in a while; part of it’s appeal is the simplicity. Put money in…any gains and income are not taxed….simple and fair (not dependent on income levels, etc.)
August 18, 2010 at 4:52 pm
@ Lise: As mentioned, the ING TFSA is at 2%, IF you have it in their high-interest savings account; it’s not their only option, however, it is their most versatile if you are using it simply as an EF — with blue chip dividends, and other equity accounts, you don’t have the same immediate access — so it greatly depends on why you’ve set up the account to begin with. In 5 months with ING, I’ve made $40+ as well, but the more major point for me is that I haven’t spent it, nor lost it in investments, and it’s there if I need it.
August 18, 2010 at 10:48 pm
My understanding is you can NOT hold stocks within your TFSA.
August 19, 2010 at 1:44 am
Cynthia – I hold stocks in my TFSA. They really are a wonderful part of an investment and retirement strategy. Yes, use it to build your emergency fund (holding cashable GIC’s etc) then if you don’t need to use it and it builds you can expand to stocks etc. I plan to have at least 5-7 years of living expenses in my TFSA when I retire. As there is no tax hit when you use it, you can use that time to move funds out of your RRSP in amounts that will let you avoid a huge tax hit as your income will be low.
August 20, 2010 at 11:16 am
Thank you sparky!
August 23, 2010 at 2:08 pm
I started an ING TFSA late last year and have a small amount directly deposited once a month. I am recently seperated and on maternity leave with my first child. I am trying to figure out the best way to invest on a monthly basis for both an EF and long term growth. I am considering mutual funds and in my TFSA, and an RRSP, but would also like to have easy access to my money as motherhood and being single are both new experiences for me (I’m not sure what to expect) Any suggestions?