My name is Mark Goodfield and I am a tax partner and the managing partner of Cunningham LLP in Toronto. This blog is about income tax, business, the psychology of money and investing topics and is meant for taxpayers no matter their income bracket, but in particular for high net worth individuals and entrepreneurs who own private corporations. I also blog about whatever else crosses my mind; I have to entertain myself. This is my personal blog and the views and opinions expressed in this blog do not reflect the position of Cunningham LLP. I am blunt and opinionated (at least for a Chartered Professional Accountant). You've been warned.

The blogs posted on The Blunt Bean Counter provide information of a general nature and should not be considered specific advice, as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Monday, September 23, 2013

TFSA Confusion – Contribution Limits, Withdrawals and Re-Contributions

John Heinzl of the Globe and Mail has an annual Investor Clinic Quiz. He stated that the quiz question he received the most emails and inquires about was a question he had on TFSA contribution limits. His readers’ confusion with this question reflects the continuing misunderstanding that exists in relation to TFSA contribution limits, withdrawals and re-contributions.

Thus, today I will revisit his question and add a variation on the question to try and further promote TFSA literacy. Finally, I have a quick comment on how many people still pay no attention to their investment strategy in their TFSA.

Question #1 – TFSA Contribution Limits


John’s question was as follows:

Dorothy is 25 years old and has contributed $3,000 to her tax-free savings account. Her TFSA is now worth $3,800. As of January 1, 2014, the maximum she could contribute would be:

a)$5,500
b)$26,000
c)$27,200
d)$28,000

Please note your answer now, before you continue reading. John states that only 40% of the respondents chose the correct answer.

Question #2 – TFSA Withdrawal and Re-contribution Limits


I am going to ask a second question, before I reveal the answer to the first question.

If Dorothy withdrew her initial $3,000 contribution in 2013: (1) what would be the maximum she could contribute in the remainder of 2013 if she suddenly came into an inheritance and (2) what would her maximum contribution room be on January 1, 2014 if she decided against using her inheritance to contribute to her TFSA in 2013?

You can try and answer this question now if you are confident you got the first question correct, or wait until I reveal the correct answer to question #1 before attempting this question.

Answer to Question #1


As John notes in his discussion of this question, the $3,800 value of the TFSA is a red herring for purposes of this question. The contribution limit when TFSAs were launched in 2009 was $5,000 a year. The limit was increased to $5,500 effective January 1, 2013. It is very important to note that TFSA contribution limits are cumulative.

Therefore, Dorothy could have made full TFSA contributions of $20,000 ($5,000 a year for 4 years)+ $11,000 ($5,500 for each of 2013 & 2014)=$31,000. As she has made $3,000 in actual contributions, her maximum contribution room is $28,000 as of January 1, 2014.

Answer to Question #2


Question #2 reflects the most common error made by Canadians each year with respect to TFSA’s – the withdrawal and re-contribution rules. According to this article in Maclean’s, last year 76,000 Canadians were issued TFSA letters by the CRA for over-
contribution penalties. I would suggest most of the letters relate to TFSA re-contributions.

As described in this CRA document, TFSA withdrawals can only be returned to your TFSA at earliest, on the first day of the next year after you  made a TFSA withdrawal. This is because the contribution room formula increases your TFSA room for any withdrawals made only in the previous year, not the current year.

For example. If you take out $5,000 from your TFSA in 2013, the $5,000 is not added to your contribution room until January 1, 2014. You cannot re-contribute the $5,000 in 2013 unless you have not made full TFSA contributions in prior years and have additional contribution room totally unrelated to the withdrawal.

Okay, back to the answer. If Dorothy received a large inheritance and decided to put the maximum amount into her TFSA in 2013, her contribution room would be $22,500 calculated as follows:

Dorothy could have made full TFSA contributions of $20,000 ($5,000 a year for 4 years)+ $5,500 (2013) less her $3,000 actual contribution (the $3,000 she took out in 2013, is not added back to her contribution room until January 1, 2014).

If Dorothy decided to wait until 2014 to use her inheritance to make her TFSA catch-up contribution, her maximum contribution limit on January 1, 2014 would be $31,000. This is the total of $28,000 as per question #1, plus the $3,000 she withdrew in 2013 that is added back to her contribution limit on January 1, 2014.

It should be noted that if Dorothy had withdrawn the entire $3,800 in her TFSA in 2013, her January 1, 2014 contribution limit would be $31,800.

Pretty easy to see why 76,000 people received TFSA over-contribution letters.

Savings Account vs Alternative Retirement Fund


TFSAs have different uses for different people. For some people it is used a rainy day fund, for others it is just a fancy savings account and for others, it is an alternative retirement fund they don’t plan to access until retirement.

The problem I see on a daily basis is that even though people as of 2013 could have contributed as much as $25,500, they still in general treat their TFSA as a daily savings account; at best they put their money in a GIC and at worst, just leave it in the account. If you look at your TFSA as a retirement account, you need to consider investing as if it were your RRSP and fully diversify your investments and maximize the tax-free aspect of the account.

As an accountant I cannot provide specific investment advice, but you need to consider whether you diversify your TFSA of its own accord, or look at the account as part of your overall diversified portfolio. For example, say you have a total portfolio of $300,000, made up of a $30,000 TFSA, $70,000 in investments and a $200,000 RRSP and your investment mandate is 10% foreign, 10% real estate, 40% equity and 40% bonds. Do you allocate your $30,000 TFSA in the 10/10/40/40 ratio, which may be impractical, or do you just have the real estate holdings in your TFSA ($300,000 x10%=$30,000).

Either way, don’t let the funds sit there and gather dust.