My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a tax partner and the managing partner of Cunningham LLP in Toronto. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. The views and opinions expressed in this blog do not reflect the position of Cunningham LLP. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned.

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.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts 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.

24 comments:

  1. I may be wrong, but don't you have to pay the US withholding tax on dividends/distributions paid on US stocks held in a TFSA? If so, I would hold one of the other asset classes there.

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    Replies
    1. Hi Bet

      In making my point about allocation, I did not give much thought to your point. But valid. I have changed my blog in that respect. Thx.

      Delete
  2. Another key factor to consider is that you own 100% of what is in a TFSA or taxable account whereas the government owns a good chunk of registered retirement accounts. Your asset allocation may not be what you think, especially since fixed income / bonds tend to be kept in the RRSP. I took a stab at showing how to adjust for tax here - http://howtoinvestonline.blogspot.ca/2012/11/tax-adjusted-asset-allocation.html

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    1. Hey CI

      Interesting point and great post you reference. I have to wrap my head around your point. I am not sure your true equity "risk" may not become overweighted even though your after tax allocation is in line. Is risk allocation and asset allocation the same thing?

      Delete
    2. Not sure if this is what you mean but I tend to believe that it makes sense to also adjust asset allocation to get a reasonable balance of risk based both on the idea of volatility and on economic environments (inflation rising vs falling, GDP growth rising vs falling) - my post here - http://howtoinvestonline.blogspot.co.uk/2013/03/new-improved-model-portfolio-smart-beta.html

      The tax allocation adjustment simply means that before doing the above "smart beta" balancing I need to recognize that my RRIF's real estate ZRE 10% is only about 7% after-tax (ie losing tax 30%, 0.3 x 10%, on withdrawal). Maybe I should do a post to show how doing both the tax- and risk-weighting together would modify the asset allocations across RRSP/TFSA and regular accounts.

      Delete
    3. Hey CI

      That would be an awesome post topic

      Delete

  3. You put a dollar in and you take a dollar out. That's what it's all about!

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  4. I have a question just to be clear for myself:
    In the last scenerio, the lady's contribution limit is noted at 31,800. So her limit is higher than someone who would have invested into their TFSA for the first time in 2014 - their limit would be only $31,000, correct?
    So everyone's maximum total limit could be changing, and differing from person to person, depending on how well their holdings within the TFSA do, correct? Is there anyway to check on the CRA site what our personal limit at any given time is? Thank you.

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    1. Yes you can get access here.

      http://www.cra-arc.gc.ca/esrvc-srvce/tx/ndvdls/qckccss/menu-eng.html

      Delete
    2. Hi Justin

      In regard to the first question, Dorothy has a $31,800 limit because her TFSA grew in value by $800 which she can re-contribute the year following her withdrawal.

      Michael, thx for the link. The only thing is, the CRA as I note below does not update for current year info. This is what the CRA says:

      Your TFSA contribution room information can be found by going to one of the following services:
      • My Account;
      • Quick Access; or
      • Tax Information Phone Service (TIPS).
      If the information that we have about your TFSA transactions is not complete or if you have made contributions to your TFSA this year, use Form RC343, Worksheet - TFSA contribution room, to calculate your TFSA contribution room for the current year. If we have deemed your unused TFSA contribution room to be a specific amount, do not use this form, call us for more information.
      You should keep records about your TFSA transactions to ensure that you do not exceed your TFSA contribution room. The CRA will also keep track of your contribution room and determine the balance of room at a particular time for each eligible individual based on information provided by the TFSA issuers.




      Delete
  5. We all know that upon death the TFSA content will be passed on to either your spouse or who ever the estate distribution decides if not.
    The question is how to pass it on as extra contribution to their TFSA without triggering CRA penalties.
    I know it can be done but I would like to know who provides such a clause in their TFSA contract. None of the online brokers permit this neither the bank I asked.
    Could someone help me?
    Also, once this question is answered, can you rescind a TFSA contract with one entity and go to another one? (that provides this special exit clause?)

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    1. Hi Anon

      I dont know the answer to your last question off the top of my head. In respect to your first question, this excellent PWC publication on TFSAs says " Alternatively, the TFSA
      ’s assets can be transferred to the survivor’s TFSA, regardless of whether the survivor has contribution room, if the transfer
      occurs before the end of the first calendar year after the year of death.

      THe link is here.

      http://www.pwc.com/en_CA/ca/tax-memo/publications/pwc-tax-free-savings-accounts-making-the-most-of-them-2013-03-en.pdf

      Delete
    2. Thank you very much for your prompt reply. The PWC document is very helpful and highlights the complicated dispositions.
      when you have the time or the information on the transfer of a TFSA from one institutions to another, I would be grateful to read your reply. As you can see I am fearful of these contracts...

      Delete
  6. Hi I just wanted to verfiy but it seems any growth within a TFSA, if you withdrew it can be re-contributed the year after your withdrawal. Specifically, say from 2009 to 2014, I had $31000 in total contribution room, and have contributed the maximum amount.

    But say my portfolio within the account is worth $60000, if I withdrew the full $60000 in later 2014. Will I have $60000+$5500 (assuming the yearly contribution room for 2015 is constant) = $65500 in contribution room in 2015?

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  7. My wife has not used her TFSA (i.e. $31,000) whereas i have put all of mine in a TFSA mainly ETFs portfolio...may I use her TFSA portion in my portfolio?

    If so, do i put the portfolio under a family title?

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    Replies
    1. Hi Donald

      No, there is no such thing as a family plan for TFSAs, unlike RESPs

      Delete
  8. If I add $5,500 to my TFSA in 2014 and then withdraw $5000 in the same year is my contribution room for 2015 $5500 or $10500?

    ReplyDelete
    Replies
    1. Hi Anon:

      You can replace the $5k your took out on Jan 1, 2015. You will also get another $5500 contribution room on Jan 1, 2015 for 2015. So $10,500 if you are including your new 2015 contribution room.

      Delete
  9. { 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. }

    In this example, does Dorothy have to contribute her TFSA to the max in order to increase her limit to $31,800? What are ways to expand the contribution limit?

    Thanks.

    ReplyDelete
    Replies
    1. no, your yearly contribution limit increases each year whether you contribute or not, however, it is reduced by any actual contributions. Her limit only increased because she withdrew money and that amount gets added back the 1st day of the following year.

      there are no ways to expand your limit, it is only expanded the first day of the next year by your prior year withdrawals.

      Delete
  10. Great source of information.

    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.

    Considering the above example, what would be the contribution room in 2014 if the portfolio loses money in 2013 to the extent of $500 from her original investment (contribution) of $3000 and she withdraws the balance of $2500 in 2013. Will the contribution room be reduced to $2500 in this loss situation as opposed to an added contribution room of $800 in your example which is the appreciation in portfolio value.

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    Replies
    1. $30,500 being the $28k as per question #1 plus 2,500

      Delete