Why do you need a TFSA? (Tax Free Savings Account)
-TAX-FREE on all capital gains made within the account (You make $5000 gain, you keep all of it: no taxes)
-Great for long term investing (Important reasons to start investing while you’re young here)
-Flexible withdrawals from your TFSA account (unlike RRSPs)
-You can invest in any stock, mutual funds, ETFs, bonds, options, GICs, T-Bills, etc. (just like a normal investment account)
-Does not impact your federal credits or benefits
-Unlike RRSPs, you can continue to invest in it even after you’re 71 years old.
What is a TFSA?
As the name implies, a TFSA is an acronym for Tax Free Savings Account.To have a basic understanding of what it is, read through the point forms below. It’s easier to explain a regular investment account first, then get into a TFSA.
A slightly more detailed example of a regular investment account will be provided further down this post.
Note: Please visit the CRA website (here) for all in depth details regarding Taxes and TFSA.
*TFSA is only available for eligible Canadians, EH.
Basics of a Regular investment account:
-Used to buy forms of ownerships: stocks, mutual funds, ETFs, options, futures, bonds, GICs and T-Bills.
-Taxed on all capital gains (CON)
-Losses can be used as reduction on payable capital gains (PRO)
Basics of a Tax Free Savings Account (TFSA):
-Can be used to buy any forms of company ownership just like a regular investment account (stocks, mutual funds, ETFs, options, etc).
-No taxes on any capital gains (including dividends) (PRO)
-No reduction on any capital losses (CON)
-You need to be age of majority in Canada to open a TFSA (19 in Nova Scotia, Newfoundland & Labrador, Northwest Territories, British Columbia, Nova Scotia, Yukon and New Brunswick, 18 in all other provinces).
-Unlike RRSPs, contributions to a TFSA are not tax-deductible
*WARNING: DO NOT OVER CONTRIBUTE*
-TFSA started in 2009, anyone at eligible age was able to contribute (you can put x [see bottom schedule] amount in the account and use that to buy stocks, mutual funds, etc., like a normal investment account), the contribution schedule is as follows:
2009: $5,000 2013: $5,500
2010: $5,000 2014: $5,500
2011: $5,000 2015: $10,00
2012: $5,000 2016: $5,500 (proposed legislation)
Example: If you were the eligible age in 2009 you would be able to contribute up to $46,500.
If you were eligible age in 2010, your maximum contribution as of 2016 is $41,500. If you were eligible age in 2011, your maximum contribution is $36,500 and so on..
Let’s say you do not contribute the max amount, you can carry-forward any unused contribution to the next year or the year after.
For instance, you are eligible in 2009 for TFSA, the maximum is a $5000 contribution but you only contribute $4000. In 2010, your maximum contribution would be $5000-$4000 + $5000 = $6000 (2009 max contribution- your 2009 contribution + 2010 max contribution).
*WARNING: Over contributing will result in a costly penalty:
Over contribution will be penalized 1% a month for every dollar over-contributed. The charges will continue as long as there is a over-contribution or if contribution room becomes available.
Example: You’ve over contributed by $5000. You will be charge $50 a month until you either remove the excess contribution, or the next contribution year comes in and allows more contribution room.
Note: 1% a month is a lot. That’s 12% a year. Be mindful of the amount you contribute and be sure to check with the CRA if you are unsure. Full details regarding over-contribution can be found on the CRA website here.
How to open a regular investment account and a TFSA?
-A regular banking institution can guide you through the process. Most banking institutions offer considerable lower trading fees nowadays compared to before. Just go in and ask about an investment account and a TFSA, make sure you bring all necessary documents so you don’t have to waste your precious time.
-You can also open an investment account and TFSA with online brokers, they generally offer cheaper trading fees than institutions and have considerably better platforms for trading.
To name some online brokers: Virtual Brokers, Questrade and QtradeInvestor.
*Always do your own research to find which institution fits your personal needs.
Basic example of capital gains and losses on a regular investment account:
Regular investment account: A regular investment account will allow an individual to buy and sell stocks, options, futures, mutual funds, T-bills, GICs and bonds. Any gains from this investment account will be subject to tax rate in your appropriate tax bracket. Any net capital loss can be used to reduce your taxable capital gains.
*For simplistic reasons, let’s not get into dividends here.
Here is an example to show the stock gain process:
For instance, you buy 1000 shares XYZ stock at $10 during February 2 2010 (You buy for $10,000).
For whatever reason, the stock is now selling at $25 May 2 2010 (You sell for $25,000).
Your total gain (profit) is $15,000. The taxable portion will be calculated as follows, as of 2000-2015, the inclusion rate is 50%, therefore you would report a taxable capital gains as $ $7,500 ($15,000 x 0.5).
You will now be taxed accordingly (depending on your income tax bracket) on the $7,500 earned.
Here is an example of a capital loss process:
For instance, you buy 1000 shares XYZ stock at $25 during February 2 2010 (You buy for $25,000).
For whatever reason, the stock is now selling at $10 May 2 2010 (You sell for $10,000).
Your total loss is $15,000. The tax reduction portion will be calculated as follows, as of 2000-2015, the inclusion rate is 50%, therefore you would report a net capital loss/ reduction of $7,500 (towards your taxable capital gains).
Basic example of capital gains and losses on a TFSA:
Basic example of gain in TFSA:
For instance, you buy 1000 shares XYZ stock at $10, a month later you sell it at a gain for $25. That’s a net profit of $15,000. You can keep all $15,000 and withdraw/ transfer it into another bank account.
Basic example of loss in TFSA:
For instance you buy 1000 shares XYZ stock at $25, a month later you sell it a loss for $10. That’s a net loss of $15,000. You take the loss and cannot have any tax reductions on this capital loss.
-TFSA provides great tax sheltering benefits, but any losses cannot be deducted from your taxes
-Keep track of your contributions as over-contributing will be penalized at 1% a month
-It does not impact your federal credit or benefits
-You can open one with any Canadian banking institution or with an online broker
-Great benefits for long term investors, especially for students at a young age.
Of course, always do your own research! Visit banking institution and the CRA website for more details regarding TFSAs. All the best, and as always, JMO (just my opinion).
“Those who keep learning, will keep rising in life”