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Tax Free Savings Accounts:  Using 2021’s Contribution Limits Thumbnail

Tax Free Savings Accounts: Using 2021’s Contribution Limits

The annual deposit limit for Tax Free Savings Accounts (TFSAs) remains at $6,000 for 2021, taking the maximum lifetime contribution to $75,500 for an individual.   Together a couple could invest $151,000, and if they earned 5% inside their two TFSAs, the $7,550 would avoid about $4,000 in income tax using Ontario’s 53% top tax bracket as an example.

Many investors underutilize TFSAs, and since we don’t have to wait until the beginning of the year to discuss the worst named financial vehicle in Canada, we could remedy a situation immediately.  Unfortunately, many investors treat TFSAs like a ‘savings account’ where they hold cash and earn interest (typically less than 1%). Most investors haven’t fully incorporated them into their overall plan by utilizing the characteristics of a registered, umbrella account, like an RRSP.  Several different vehicles that generate interest, capital gains and dividends can be held.  

Many Canadians have TFSAs elsewhere, often at a major Canadian bank that they opened at a branch.  After an initial deposit the cash continues to reside there, underperforming.  Any cash that isn’t needed for liquidity and is sitting idle, could be earning tax-free income inside a TFSA.  

The Details

The lifetime limit for TFSA contributions is currently $75,500 based on 2009 to 2012’s limit of $5,000, 2013 to 2018 at $5,500, except for 2015 at $10,000, and $6,000 for 2019 through 2021.  To qualify, an investor must be 18 to open a TFSA and have a valid Social Insurance Number. 

TFSAs are also an excellent vehicle to augment Registered Education Savings Plans (RESPs), which prohibit contributions after the student reaches 18 years of ages.   By sheltering investment income from taxes, “paying” into a TFSA to generate income could save a year’s tuition in taxes by the time they graduate.

Any funds sitting in a “cash account” (unregistered account) could be transferred to a TFSA to fill any unused contribution room to allow these funds to grow tax free. Cash sitting inside these unregistered accounts can be transferred easily and without worry of triggering a tax liability.

If a transfer is made in-kind the current market value must be used. If the securities have grown in value from purchase to transfer, this gain must be declared as income (unfortunately, losses cannot be claimed) on the next tax return. Consequently, whenever possible, deposit cash to a TFSA, and then invest it once it is inside this account. Or sell the securities in the unregistered account and transfer the cash to the TFSA.

Key Factors to Know

Since the lifetime contribution limit for a TFSA is currently $75,500, a two-person household could invest $151,000 in their TFSAs.  A couple with two adult children could shelter as much as $302,000 inside their TFSAs, and all of it could earn income tax-free!  To reach the maximum the children would have to have been 18 years old in 2009, which means they were born in 1991 or before.  Transferring wealth between generations can be a taxing proposition, and TFSAs could play a role for some families.  Like many other complicated situations, an early start to planning is the best choice in an effort to make all alternatives available.

A “TFSA Review” could identify more efficient ways for a family to maximize its use of this type of registered account.  If $302,000 in holdings earn 5% the funds would generate $15,100 annually in income.  Shielding that income from CRA’s taxing ways will save a family $8,003 assuming a 53% marginal tax rate, if no registered vehicles are used. 

The original plan for RRSPs was to allow high income Canadians to defer income and associated tax until they had retired.  The notion was that their income in retirement would be lower and they would pay less income tax since they were in lower income tax brackets.  Unfortunately, this does not occur as well as originally conceived.  Balancing RRSPs and TFSAs, along with other tax advantaged investments is necessary.   

The added bonus of the TFSA is that the earned income is never taxed! The capital that gets deposited was taxed when it was earned, so when it’s withdrawn from the TFSA it won’t be subjected to income tax, and the capital gains, dividends and interest earned are withdrawn without income tax liability.

Additionally, in the calendar year following your withdrawal, your contribution room is restored.  We could establish a “deposit-earn-withdraw” ladder to achieve returns like your RRSP, but free of tax liabilities when you receive your invested fund back.

The Bottom Line

We should ensure that your TFSA is utilized each year so that a tax-free source of income can be established in concert with all of your registered and non-registered accounts.  At various times income has been difficult to earn, and savings have been even harder to achieve, there is no reason to share the fruits of your labour and discipline unnecessarily with CRA.