Managing Forward with TFSA Misses in Focus

Evelyn Jacks & Walter Harder

A new study on the savings habits of Canadians in their Tax Free Savings Account (TFSA) conducted by the Bank of Montreal, sheds light on many missed opportunities. But it’s not too late for investors to catch up and thrive with this completely tax-free opportunity.

The study notes that only 53% of Canadians contributed to their TFSAs as planned this year, compared to 58% last year.  Clearly, that pandemic may have had some influence here.

However, contributions themselves, on a year-over-year basis, have increased by 9.5% with estimates that excess savings reached $150 billion.  That equates to  average account holdings around $31K.

The report also made it clear that many still have knowledge gaps about what the TFSA can be used for and how it works. Specifically, too many contributors are not “investing” – rather just holding cash in these accounts.  This is a missed opportunity and investors might wish to prod their financial advisors for information on how to get better returns.

Here’s a conversation primer on considerations before year-end.

The Tax-Free Savings Account (TFSA) has been with us for more than a decade now, yet there are many misconceptions about it. For example, the 2020 contribution limit is $69,500 for those who have been eligible to contribute every year since 2009. That’s residents of Canada who are 18 or over. If you turned 18 in 2020, you would contribute based on the current year limit of $6,000.

The lifetime maximum goes up another $6000 on January 1, 2021.  That’s a total of $75,500 for the 12 years, so be sure to contribute in the new year to continue earning tax free returns.

One of the benefits of a TFSA over an RRSP is that, after a withdrawal, the gap in the lifetime contribution limit can be replenished. However, what many individuals do not understand is that the contribution room cannot be replenished until the following year. If you re-contribute to the plan before this, you’ll be subject to a 1% per month penalty on the excess contribution.

Here’s an example: Tyrone’s 2020 TFSA contribution room, as shown by CRA, was $10,000.  In February, he withdrew $25,000 from his TFSA.  He is considering a recontribution in December 2020.  How much can Tyrone contribute to his TFSA, and when?

Until the end of 2020, Tyrone’s total contributions for 2020 must not exceed $10,000. 

If Tyrone re-contributes the $25,000 withdrawal in 2020, he’ll be liable for a penalty of $250 because this is considered to be an overcontribution until the new contribution room opens up in January 2021.

Be sure to speak to a DFA-Tax Services Specialist™ to help you manage your TFSA contribution and re-contribution room to avoid the 1% per month penalty and file the TFSA Return and its accompanying Form RC243 Schedule A – Excess TFSA Amounts to report the 1% tax.  Failure to file the TFSA return can result in late filing penalties as well. 

Additional educational resources: Learn more about TFSAs and other registered and non-registered tax-efficient investment options in the certificate course Investment Tax Strategies. Or enrol in the MFA™- Pension & Estate Services Specialist Program designation and add a highly prized service to your career: custom-design tax-efficient retirement income plans. Enrol or take a free trial today.