The Canadian Money Roadmap

TFSAs are great but watch out....

August 04, 2021 Evan Neufeld, CFP® Episode 24
The Canadian Money Roadmap
TFSAs are great but watch out....
Show Notes Transcript

EPISODE SUMMARY

TFSAs are the best way to invest smarter and reduce taxes over the long term.  But you’ll want to be careful of some of these critical pitfalls that can get you into trouble.

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TOPICS IN THIS EPISODE

  1. Quick refresh on what a TFSA is and how it works 
  2. Explanation of TFSA contribution room and how it accumulates 
  3. Overcontribution rules and penalties 
  4. How you can’t claim capital losses in a TFSA 


RESOURCES MENTIONED

Government of Canada - TFSA Guide


OTHER EPISODES

10. Using a TFSA Like a Pro

29. RRSP, LIRA, TFSA…Where do you Withdraw from First? 

36. 5 Steps to Set Up Your TFSA for 2022


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Hello, and welcome back to the Canadian money roadmap podcast. I'm your host. Evan Neufeld. Today is part five of my summer series where I’ll have shorter, more frequent episodes on the topics of investing smarter and reducing taxes.

First and foremost, today I apologize for the late upload on this episode. I've had some dental work done recently and so you might also hear a few little extra S’s or oddities with how I sound, but I wanted to make sure I get this episode out to you regardless. So today I wanted to talk about the TFSA.  TFSA is the undisputed king of investing smarter and reducing taxes, the main reason is because when you invest with a TFSA, all of your investment growth is yours to keep forever. You never have to share any of that with the government. You don't have to deal with tax credits or worrying about your income or anything like that.

If you're investing in your TFSA, you are growing money and you get to keep all of it.  That is the simplest way to invest smarter and reduce taxes that is available to Canadians full stop. But today I want to talk about some of the pitfalls to be aware of when it comes to investing in a TFSA.  The first one is about how you accumulate TFSA room. So as soon as you turn 18, you qualify to open a TFSA. Now the problem is people turn 18 at different times, of course. And when you turn 18, you receive the contribution room available to all Canadians in that year. So if you turned 18 long before the TFSA launched, you have every year's worth of contribution room because you're already 18 when the TFSA launched in 2009.  

The room has changed over the years. The first year you could do $5,000 and you could do that for several years. And then they increased it to 5,500 to account for some inflation. And then the government at the time was trying to get reelected, so they gave a one-time bump up to 10,000 and then the elected government that got in, they decided to bring it back down and then it was at 6,000 for a while. That's where it is today.

So whenever you do your calculation of how much contribution room you have, you can find a number of calculators online, but it's all based on the year that you turn 18. 

If you turned 18 in the year where they offer the $10,000 one-time contribution rate, then you would be able to take full advantage of that. But if you turn 18 afterwards, you don't get that benefit unfortunately. Now the thing that will apply to some other people when it comes to the contribution room is residency.

So you accumulate TFSA a room not based on citizenship, as being a Canadian citizen with a Canadian passport, but it's based on residency. So if you reside in Canada and you're over the age of 18, you would accumulate TFSA room.

If you are someone who say works overseas or I know of a few professional athletes certainly played volleyball or hockey or something like that over in Europe. If you are a non-resident for a complete year, you would not accumulate TFSA room for that year. I know a number of people that have moved away for a little while and went in to say, test the beaches out in Australia for a few years, or do some traveling for an extended period of time and they would have residency elsewhere. So for those years, if this applies to you, you have to be really careful that even though you remain a Canadian citizen and even if you're coming back to Canada for the years that you were a non-resident, you do not increase your TFSA room during those years.

Now, I guess I should maybe clarify what happens if you over contribute. So say you have the maximum amount of 75,500 of contribution room. Say you've taken advantage of all of that in your TFSA. But for whatever reason, maybe you forgot or there was an accident or something like that and you over contributed, you put too much in there, you put 80,000 in there. What happens is you'll get a nasty letter from CRA more often than not, it's a warning if it's your first time or if it appears to be an accident. But if it looks a little bit more egregious, or maybe this is time three or four or something like that, they can give you a penalty and the penalty for over contributing to a TSA is pretty ugly.

They would charge you 1% per month on the amount that has been over contributed. So that can really add up, especially if you're contributing significant amounts of money to your TFSA. Now, the way to get around that, which you'll see in the letter is that You can remove the amount of the over contribution and your financial institution will then notify CRA the following year so that they know that you've actually made that withdrawal. But also if you wait for the next calendar year, when you get additional contribution room, they wash each other out.

So I'm not telling anybody to take a penalty or pay 1% TFSA tax for any reason. But if you wait for the following year, there is a chance that the elapsed time and the additional contribution room will take care of your over contribution problem.

Finally the last TFSA pitfall that you want to be aware of is the fact that you cannot claim capital losses in a TFSA. Let's break that down a little bit. So there's a couple of ways where this might create some problems for you. So if you use your TFSA for investing in specific stocks, Those stocks have a chance to go to absolute zero, especially if you're investing in things that are very risky. So say for example, you owned a stock that went to zero. You put $5,000 into the TFSA and it went to zero. You can't get that money back. There's no stock to sell anymore. Nothing. You cannot get that $5,000 of contribution room back ever, because again, it's not based on what the account value is worth or what the investment has done, it is based on what you have put into the plan.

So if you put $5,000 in, you can't take any money out. You made your contribution and you have to live with the consequences. And so that TFSA room is gone forever. Second way that this shows up, it doesn't have to be a gone forever situation, but let's look at an alternative in a non-registered account.

So when you have a non-registered account, again, you pay taxes when you make money. One of the ways that you do that typically is when it comes to investing is through capital gains. So you pay some taxes when your investments increase in value. Now, the nice thing is if your investment decreases in value and you sell it, you can lock in a loss, which you can use to offset gains in another year.

TFSA you cannot do that. Same things in RRSP to TFSA as well. You cannot use capital losses to offset future gains. So again, if you're trading stocks or you're in investments that are quite volatile or you're buying and selling things quite often, you cannot use any losses in your TFSA to offset any gains.

The main reason is because any gains that you have in the TFSA are tax free anyways, but you can't use it to offset gains that you would have elsewhere. So just keep that in mind that if, as your investments increase  or decrease in value, No, you don't have to pay any tax on the gains, but you also don't get the benefit of offsetting gains elsewhere with losses.

The main way to avoid the issue of capital losses is to use diversified portfolios in a TFSA. I've talked about understanding your own risk profile and things like that, and understanding how much you should have in stocks and bonds and everything there. So you should make sure to stay within that range. But even if your risk profile says that you should have a hundred percent stocks in your portfolio, make sure you have a diversified portfolio if you're using a TFSA, because if things go wrong you don't have the opportunity to claim a loss in that case and the TFSA room is gone forever. So make sure you're using diversified portfolios, ETFs, mutual funds, things like that, to make sure that you're getting the most bang for your buck when investing in at TFSA.

Thanks for joining me today on the Canadian money roadmap podcast. If you enjoyed today's episode, I'd really appreciate if you left me a review on apple podcasts with your biggest takeaway. If you have questions or ideas for topics you'd like me to discuss on future episodes, please reach out via my contact info in the show notes.

This podcast is intended to be educational in nature, and you should always consult your financial, tax and legal advisors before making changes to your financial plan. Any rates of return discussed are historical or hypothetical and are to be used for educational purposes. Evan Neufeld is a Qualified Associate Financial Planner and registered investment fund advisor.  Mutual funds are provided through Sterling Mutuals Inc.

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