Dale Jackson

Personal Finance Columnist, Payback Time

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But it’s not that simple. There are rules and restrictions on TFSAs that could wind up costing wayward investors in lost opportunity and even penalties. Here are the facts on eight common misunderstandings:

TFSA CONTRIBUTIONS CANNOT BE DEDUCTED FROM TAXABLE INCOME

Many Canadians confuse TFSAs with registered retirement savings plans (RRSP), which allow contributions to be deducted from their income to generate a tax refund.

While TFSA contributions don’t deliver an immediate tax break, withdrawals are never taxed. In comparison, RRSP contributions and all the gains they generate over time are fully taxed when they are withdrawn.

A TFSA IS NOT A 'SAVINGS' ACCOUNT

Despite having the word “savings” in it, treating your tax-free savings account like a conventional savings account at a bank is pointless. Since only investment returns are tax exempt, money in a TFSA should be invested. 

TFSAs can be invested in just about anything - stocks, bonds, mutual funds, exchange traded funds (ETFs). The recent rise in interest rates have boosted yields on fixed income, such as guaranteed investment certificates (GICs), which currently pay out over five per cent annually with no risk.

YOU CAN NOT RECONTRIBUTE WITHDRAWALS IN THE SAME YEAR

If you withdraw cash from your TFSA, the allowable contribution space will not be restored until the following calendar year.

It’s not a big deal if you have plenty of allowable space, but those who max out their TFSAs need to wait until the following year. 

YOUR FINANCIAL INSTITUTION WILL NOT KEEP TRACK OF YOUR LIMIT

Over-contributing to your TFSA could result in a penalty from the Canada Revenue Agency (CRA).

Allowable contribution space is added each year. The current limit for those who were 18 years or older when the TFSA was launched in 2009 is currently $88,000, but it can vary among individuals depending on withdrawals made over the years. 

Many Canadians contribute to their TFSAs through more than one institution and it is the account holder’s responsibility to ensure they don’t exceed their limits. 

DON’T COUNT ON THE CRA TO ACCURATELY TRACK YOUR CONTRIBUTIONS, EITHER

The CRA provides TFSA limits in annual Notice of Assessments on individual tax returns, and for individual taxpayers who set up a CRA online account. Contribution limits posted by the CRA, however, are usually for the previous year.

Be sure to include contributions made in the current year when tallying your limit.

CAPITAL LOSSES CAN NOT OFFSET CAPITAL GAINS

Tax-loss selling is a popular strategy for investors who want to lower their tax bills by deducting capital losses from the sale of losing stocks against capital gains generated from winning stocks.

That only applies to non-registered accounts. Since capital gains are never taxed in a registered TFSA, there’s nothing to offset capital losses against. 

U.S. DIVIDENDS ARE NOT TAX FREE 

Add the words “tax free” to “savings” and three of the four words in tax-free savings account are misleading. 

Non-Canadian dividends generated in a TFSA are subject to a withholding tax on behalf of the U.S. Internal Revenue Service (IRS). That includes the big U.S. blue chip companies that Canadians love to own. It also includes U.S. mutual funds or exchange traded funds (ETFs), and even Canadian mutual funds and ETFs that hold U.S. equities. 

TFSAS ARE GREAT FOR LONG-TERM RETIREMENT SAVINGS 

The TFSA is generally seen as a short-term savings tool to finance things like a new car, a pool or that big vacation. That’s true, but it can also be an effective retirement savings tool to work in conjunction with an RRSP.

As mentioned, RRSP contributions and any gains they generate as investments are fully taxed when they are withdrawn. If those investments grow too much, retirees could be forced to make withdrawals in a higher tax bracket and even face Old Age Security (OAS) claw backs.

Splitting retirement savings between an RRSP and TFSA allows you to limit RRSP withdrawals to the lowest tax bracket, and top up required funds with non-taxable TFSA withdrawals. It’s a great way to keep more of your retirement dollars in your pocket.