Some Limitations…
There are, however, some important limitations to how you can access the account that you should be aware of. Probably the one that causes the most trouble for people is in understanding how money can be put back into a TFSA after it has been withdrawn. Even though you can withdraw money from a TFSA without any tax penalties, you have to keep track of how much you removed and how much contribution room you have left for the year because the CRA will penalize you if you over-contribute (i.e. put more money in your TFSA than you are allowed to).
Let’s use an example to clarify. Suppose you have $5000 of contribution room in 2010 and you decide that in January you want to put $4000 into your TFSA. Since you have $5000 of contribution room then depositing $4000 will not exceed your contribution limit and therefore not result in any penalty and it leaves you with $1000 of contribution room for the rest of the year. Now let’s suppose that in June you need to make some repairs to your home so you remove the $4000 from your TFSA.
Here’s where it gets a bit tricky – because you have already made a “contribution” of $4000 you only have $1000 of “contribution” room left for the calendar year of 2011. If you decide to put money back into the TFSA, that would count as a “contribution” and so you would only be allowed to “contribute” $1000 more for that year. If you tried to deposit $4000 you would actually go over your contribution limit by $3000 ($1000 remaining contribution room – $4000 deposit) at which point CRA would penalize you for every month you have that excessive amount ($3000). To quote the CRA website:
You cannot contribute more than your TFSA contribution room in a given year, even if you make withdrawals from the account during the year. Withdrawals from the account in the year will be added to your contribution room in the following year. If you over-contribute in the year, you will be subject to a tax equal to 1% of the highest excess TFSA amount in the month, for each month you are in an excess contribution position (http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/tfsa-celi/wthdrwls-eng.html )
Although it sounds a bit complicated, just remember that your total deposits for the year cannot be more than your contribution limit each year, regardless of how much you remove. The good news is that you “get back” the contribution room at the start of the following year. So in our example above if the contribution room as of January 1st 2011 is set to $5000, that would mean that you could deposit up to $5000 + $4000(the amount you removed from the past year) = $9000.
Why get one?
Earning money is hard enough for most people, so when we see those deductions from our paycheques we know that what we earn isn’t necessarily all we take home. While it’s not a knock against taxes, from the point of view of the individual, to get ahead you and your money have to factor in taxes. Having the opportunity to put your money to work and then be able to have it grow means that it is working more efficiently. Remember that the harder your money works, the harder you don’t have to.
While traditional savings strategies are safe, they typically do not earn much of a return. On the other hand, because you are able to buy other investment products through your TFSA (such as stocks) you are able to take advantage of more strategies (such as dividend paying strategies or capital gains strategies) without incurring extra tax consequences. Another important catch however is if you decide to invest the money in your TFSA in a stock and you suffer a loss on the stock, you can’t claim the capital loss against any capital gains.
There are many reasons people open up and keep a TFSA – they may be saving for a rainy day or just saving for a special vacation or specific purchase. Others use their TFSA to get the most out of their investments. For those who like to trade stocks and are good at it (big catch there!) a TFSA is an amazing opportunity to lock in tax free gains. While TFSAs are a lot like other normal bank accounts, there are some things you’ll want to be aware of if you have one or are looking around for one.