Your TFSA questions answered

We asked MoneySense.ca readers to ask their own questions about TFSAs. Here, financial educator and writer Lynn Biscott answers the best questions. (We are no longer taking new questions.)

David T. asks: What are the differences between the “successor holder” and “beneficiary” designations and which is the best way to proceed in regards to my spouse? What are the benefits of one designation over the other?

This is a great question, David, because people seldom think about what will happen to a TFSA once they pass away – and they should. In general, a spouse should be designated as a successor holder rather than a beneficiary. Here’s why.

When you die, your spouse, as successor holder, becomes the new owner of your TFSA. The value of the TFSA and any income it earns after you die continues to be sheltered from tax under the new owner. The surviving spouse can continue to maintain the account, and can contribute new money, subject to her own unused contribution room.

If your spouse was designated as beneficiary, the situation is more complicated. When your estate is settled, the full value of the TFSA will be paid to your spouse. She has the option to contribute an amount up to the value of the TFSA on your date of death to her own TFSA without impacting her contribution room. However, this must be done within a certain time frame, and paperwork has to be filed with Canada Revenue Agency (CRA) when the contribution is made. In addition to these complications, any income or growth earned by the TFSA after you die is fully taxable to your spouse.

So, in order to make sure that the TFSA passes to your spouse as simply and as tax-effectively as possible, the successor holder designation is the way to go.

Note that only a spouse or common law partner qualifies as a successor holder – anyone else must be listed as a designated beneficiary.

Barry W asks.: Is the CRA’s notice of assessment really a useful tool for figuring out your TFSA room? My experience is that the Notice of Assessment, received in 2010 for the 2009 tax year, is received far too late. By the time I receive it in May, June or July, roughly half the year has passed during which possible gains on the additional contribution are lost.

This is a very valid point, Barry. It’s also possible that, at the time CRA issues your Notice of Assessment, they may not have received or finished processing the information from the issuer of your TFSA. Your best bet is to keep track of your own contributions and withdrawals, so that you know how much you can contribute each January.

Jim asks: Can you transfer stocks, bonds, etc from your RRIFs to your TFSA without selling the stock or bond?

It is possible to transfer investments from a RRIF to a TFSA, but not without paying the tax man! Whatever you transfer out of the RRIF will be reported as a withdrawal and included in your income for that year. But, if you don’t need the cash from the RRIF to cover expenses, you can certainly continue to hold the stocks or bonds in your TFSA and shelter them from tax on any future growth or income. The fair market value at the time of transfer is used to determine the amount of the RRIF withdrawal and the TFSA contribution.

USD asks: How does foreign currency work in a TFSA? I was able to use US $ in the TD e-Series funds, I am wondering how that affects my contribution room?

When you contribute foreign funds to a TFSA, the institution that issued the TFSA is responsible for converting the funds to Canadian dollars on the date of the transaction. This is the amount that is then reported to CRA. You would need to contact your TFSA issuer to find out the exact amount they reported.

Jenny asks: When you are doing taxes, do you have to enter anything to record what you have in for the TFSA? I’m not sure how the government would keep track of it otherwise?

Not to worry, Jenny, there’s nothing you need to report on your tax return when you put money in or take money out of a TFSA. The financial institution that issued your TFSA is responsible for reporting all these transactions to Canada Revenue Agency (CRA).

W H asks: I have maxed out the total $10,000 contribution room to TFSA ($5,000 from each of 2009 and 2010). My income for 2010 would be well below the sum of personal exemption amount and all applicable federal and provincial non-refundable tax credits. I would have no payable income tax for 2010.

It will be a new $5,000 contribution room available on January 1st, 2011. Would it make sense to withdraw $5,000 (or a portion of it) from RRSP before December 31st, 2010, hang on to it for 1 day, and then contribute to TFSA on January 1st, 2011?

Although whatever the amount to be withdrawn from RRSP is taxable (T4RSP) in 2010, and the original RRSP contribution room is not recovered, but in this case with the excess non-refundable tax credits, tax payable is zero. Also, the original contribution served the purpose – tax deferred when tax rate was high, and taxable when tax rate is zero.

This sounds like a reasonable idea. As you point out, you’ve already benefited from the tax deduction you got when you made the contribution to your RRSP, as well as the tax-sheltered income on the contribution over the past several years. If you can withdraw the money now without paying any tax on it, and continue to tax-shelter the income or growth in a TFSA, you have the best of both worlds. Nice going!

W H asks: Would it make sense to put dividend-paying investments in TFSA?

For Canadian dividend, the favourable dividend tax credit is not available in TFSA.

For foreign dividend, which is subject to foreign withholding tax, but the foreign tax credit is not available in TFSA. Also, I think the special clause in the Canada-US tax treaty regarding withholding tax exemption in RRSP, does not apply to TFSA. Any foreign tax paid became a non-recoverable and non-deductible expense.

Although any capital gain is tax-free, but as a double-edged sword, any capital loss is lost and non-deductible for capital gain in non-registered accounts.

From a tax perspective, it’s best to hold Canadian dividend-paying stocks in a non-registered account where you’ll be able to take advantage of the dividend tax credit. With foreign stocks, there is no dividend tax credit, but you have the issue of foreign withholding tax to consider. In a non-registered account, you can recover at least part of the withholding tax by way of the foreign tax credit. In addition, as you point out, the US does not withhold tax from dividends paid into an RRSP or RRIF. However, this favourable treatment does not as yet apply to dividends paid into a TFSA.

For these reasons, I tend to prefer using a TFSA to hold investments that would otherwise not enjoy any favourable tax treatment, i.e. bonds, term deposits, and GIC rates. Having said that, however, you need to start out by looking at your overall asset allocation. The first order of business is to figure out the best mix for you between cash, fixed income, and equity investments. Then you can decide what investments to hold where.

Frank McAllum asks:

I have two questions and both are related to the $5000/year contribution:
1) Regardless of the contribution room available, does the $5000 contribution limit per year apply?
2) If I withdraw $X from my account, can I replace $5000 plus $X the following year?

Interesting questions, Frank. First, your total contribution room is what determines how much you can put into a TFSA each year. So, if you have not yet established one, but you’ve been a resident of Canada over the age of 18 since 2009, you could contribute $10,000 to a TFSA this year.

To answer your second question, suppose that you make your $10,000 deposit in October and then withdraw it the following month.  As of January 2011, your contribution room will consist of the $10,000 you withdrew, plus the allowable amount for 2011. This will likely be $5,000, unless the government increases the amount for inflation. So yes, any amounts withdrawn are added onto your contribution room for the following year.

Daniel asks: At which tax marginal rate would a RRSP start to be better than a TFSA? Does it have the same impact whichever the province of residence (Quebec vs. Ontario)?

Ah, the TFSA versus RRSP question! To answer this one, you need to look at the level of your taxable income today versus the taxable income you expect when you retire. For example, if you’re just starting out in the working world, chances are your income isn’t particularly high today in relation to what it could be down the road. In that case, you’re not going to get a significant tax benefit by investing in an RRSP right now. You’d be better off contributing to a TFSA. You can always use the money in the TFSA to make RRSP contributions in the future if and when you start making big bucks.

The general rule of thumb is that, if you’re in a higher tax bracket today than you will be when you retire, the RRSP is the way to go. If that’s not the case, the TFSA may be the better route.

The website www.taxtips.ca has some handy charts that show the tax rates that apply to different levels of income depending on the province or territory where you live.

Karen asks: Who should have a tax free savings account?

The better question might be: who shouldn’t? In my view, they can be useful for just about anyone – young people saving up for a first home, car, or other major purchase; low to middle income people saving for retirement; higher income people who max out their RRSPs each year, but want additional savings; wealthier individuals of all ages with non-registered accounts in addition to RRSPs or RRIFs.

Anyone who has income from a non-registered investment that they’re paying tax on can benefit from sheltering that investment in a TFSA.

Grampa Deane asks: I would like to put a USD equity in my TFSA but I am concerned about how the currency conversion will affect the purchase and is there any agreement to have the with-holding of US tax on dividends returned to the TFSA holding without prejudice?

When you transfer a US stock to a TFSA, the bank or broker converts the funds to Canadian dollars when you make the transaction. The Canadian dollar amount is the amount of your contribution.  If your plan is to use money already in the TFSA to buy a US stock, then you don’t need to worry about the currency conversion at all.

As discussed with WH above, within a TFSA you have the issue of foreign withholding tax to consider. In a non-registered account, part or all of the withholding tax can be recovered by way of the foreign tax credit. In addition, the US does not withhold tax from dividends paid into an RRSP or RRIF. However, this favourable treatment does not as yet apply to dividends paid into a TFSA.

Richie asks: If I buy 1 Share of  ‘Magic Stock’ for $1 today, and it grows to $1 Million by November, and in December I cash out the lot, can I replace the full $1 Million the following January?

In a word, yes. Any amounts you withdraw from a TFSA, including both the original contribution and the income or growth, are added onto your contribution room for the following year. And, of course, your capital gain of $999,999 will be completely tax-free. Now, you just to have to find that magic stock!

Csplice asks: Is it possible to set up a joint TFSA account with my spouse in the same way that my kids family RESP account is set up?

Nope, there’s no such thing as a joint TFSA account. However, you and your spouse can each have a separate TFSA, and one of you can give the other money to make a contribution. You can name one another as “successor holder”, so that, when one of you passes away, the survivor simply becomes the new owner of the plan.

Gfbrnby asks: In your article you warn that recontribution of amounts withdrawn from a TFSA can cause an overcontribution penalty. Does that only apply if you recontribute an amount in the same year that you withdraw it? For example, in 2010 I contribute $5K and withdraw $2K. If I recontribute the $2K in 2010, I’ll exceed my 2010 limit, but if I contribute $7K in 2011 ($5K allowance plus $2K recontribution) I’m OK?

You’ve got it. This is one of the finer points of the TFSA that many Canadians missed. Earlier this year, lots of folks were assessed penalties by Canada Revenue Agency (CRA) for re-contributing amounts in the same year that they were withdrawn. Technically, this results in an overcontribution. The rules say that any amounts withdrawn are added to your contribution room for the following year.

Katie asks: I currently hold some independent mortgage funds (some with the fund manager and some in an RRSP at my brokerage house – about $47,000 worth). The mortgage funds to date have paid dividends of 7 to 9 percent. Neither my husband or I have contributed to a TFSA yet and therefore would have $10,000 each. I have 4 questions. 1) Can I put mortgage funds into a TFSA? 2) Can I buy the mortgage funds and put $10,000 in my account and $10,000 in my husband’s account? 3) Do I have to use my brokerage house to hold the accounts? They charge me 1.5% on any and all investments. 4) Would I be better off buying a TD-e-series index fund at this time? My risk tolerance is mid range.

Ok, let’s deal with these one at a time.

1)     Yes, you can hold mortgage funds in a TFSA. In fact, you can hold any investment that’s also eligible for an RRSP – stocks, bonds, mutual funds, etc.

2)     Yes, even though the $20,000 is all yours, you can give $10,000 to your husband to open a TFSA in his own name. Just remember, the money’s now his and he can do what he likes with it.

3)     You can open a TFSA anywhere you want. While there are advantages to having one advisor oversee your whole portfolio, it’s certainly not a requirement. If you’re thinking of transferring some of the funds you already own, this can easily be done.

4)     I’d have to know way more about your situation to be able to give you this sort of advice. First of all, you need to look at the purpose of the TFSA – is it for a short-term goal such as saving for a house or other major purchase, or is it a supplement to an RRSP for long-term retirement saving? You also need to look at your overall asset allocation. You mention your mortgage funds, but I don’t know whether or not you have other holdings. Mortgage funds are a fairly conservative investment, which may or may not meet your needs. I would suggest you sit down with a Certified Financial Planner to review your situation. Visit the Financial Planning Standards Council at http://www.fpsccanada.org/directory-cfp-professionals-good-standing to find someone in your area.

Tony Campbell asks: I bought $5,000.00 in shares in a company in 2009 for my TSFA. I bought $5,000.00 in shares in a different company in 2010 for my TSFA. The shares in the 2009 company have gone up approximately 60% and they are worth about $8,000.00. I did not ask that the dividend be reinvested so there is also about $400.00 in cash from this investment in my TSFA. The shares in the 2010 company have gone down about 40% and are now worth about $3,000.00. There was no dividend. In total I now have about $11,400.00 in my TSFA.

I am going to cash in my total TSFA this fall ($11,400) and invest to the maximin in January 2011. I think this will be $11,400. + $5,000.00 for 2011. (total $16,400.00) However, I am not sure. For example, could I claim the loss of $2,000.00 on my 2010 investment and put back $5,000.00 in my TSFA for 2010, instead of the $3,000.00 that I will sell it for this fall. Also, is the dividend ($400.00) for 2009 just considered part of the the total value of the TSFA for that year?

Your original interpretation is correct. Whatever amount you withdraw from a TFSA is added onto your contribution room for the following year. It doesn’t matter whether this amount consists of your original contribution, or the interest, dividends and/or capital gains that your investment earned.

Just as capital gains are not taxable when earned in a TFSA, capital losses are not deductible.

Sharon asks: What is the best way to transfer a stock from your RRSP to a TFSA?

You can make a direct transfer of a stock from an RRSP to a TFSA, but you need to be aware of the tax implications. The transfer will be reported as a withdrawal from your RRSP, and will be included in your taxable income for the year – probably not the outcome you wanted. Unfortunately, there’s no way to transfer an investment without incurring tax.