Episode 8: The Swiss Army Knife Investment Account

[00:00:00] Scott: Welcome to the Retire Ready Podcast. The podcast that helps Canadians prepare for all that retirement brings. I'm your host,Scott Sather, Founder, President, and Financial Planner at Awaken WealthManagement. And portfolio manager with Awaken Investments of Aligned Capital Partners in Regina, Saskatchewan. Thanks for joining me today.

[00:00:21] In this episode, we're going to continue talking about the different accounts available for retirement savers.

[00:00:26] Last time we discussed the ins and outs of the RSP. So today we'll discuss an often misunderstood account. The tax-free savings account or TFSA. Now, if you listen to the last episode, you'll notice a theme of most of these registered investment accounts being misunderstood.That's exactly why I'm doing this series. With the RSP, it came down to many, not liking it due to the taxes owing upon withdrawal. But that was because the account provided a tax deduction when the contribution was made.

[00:00:56] The issue with the TFSA is right in the name.

[00:00:59] No, [00:01:00]it's not the tax-free part. That one is fairly easy to understand. But may behard to trust, like, is it really tax-free? Yeah, it really is. It's more the savings account part, which has led many to accept lower interest rates andinvesting options as they just didn't understand the account. Didn't get thea dvice.

[00:01:19] They should have an open it up at their bank. And by doing so missed out on the huge benefit of the account. Allowing tax-free growth. So let's jump in. What is the TFSA, who is it for? How much can you put into it? How do you take money out of it? The tax-free savings account or TFSA is a registered account in Canada that started in 2009. It's available for individuals 18 years of age or older, who have a valid social insurance number, and it allows them to set money aside tax-free throughout their lifetime.Contributions are not tax deductible.

[00:01:53] I repeat not tax deductible. That means you're putting in after tax dollars into the TFSA, [00:02:00]you've paid the taxes on the money and then are investing in the account. Any income dividends or capital gains though were earned inside the account are tax-free to the account holder. Even when withdrawn. So again, The TFSA is justa n account, not an investment.

[00:02:16] You can hold multiple TFSA accounts at different institutions, if you so desire will, but we'll talk about why you might not want to do that as it can cause confusion and result in penalties due to over contributing. Contribution room for the TFSA is based on when you turned 18 as that's, when you start accumulating that contribution room. So if you're turning or turn 18 and 2024, you can contribute $7,000 this year. If you don't contribute this year, your room continues to build the account.

[00:02:49] Originally started with a $5,000 limit to contribute back in 2009. Stayed at that level. Until around 2013, when it increased to $5,500 for the [00:03:00] next two years before getting a big boost all the way up to $10,000 in 2015.Unfortunately the new government at that time, dropped it back down to $5,500for 2016 to 2018. Increased it to 6,000 for 20 19, 20 22. 2023, saw the limit increased to $6,500. And then, like I said, $7,000 in 2024. The limit is indexed to inflation and rounded to the nearest $500 which is why we saw it bump up from $6,000 to $6,500 and then $7,000 in such a short period of time.The maximum. Cumulative amount in his $95,000 right now, meaning if you turned18 back in 2009, or before that. And you've never contributed to the TFSA.Again, assuming you're a Canadian resident. Your limit is $95,000. Now, one of the big benefits of the TFSA is that [00:04:00]as you draw money out of the account or withdraw from it, you receive that amount back in contribution from the following year.

[00:04:06] Again, you have to wait until the following year to get that contribution room back.

[00:04:11] So if you've never contributed and then fullymaxed out early in 2020 for the full $95,000. And then later in the year youneeded some and withdrew $50,000. You will be able to contribute that back.Come January 1st, the following year in this case, that's January 1st, 2025.This amount you take out can also be growth in the plan. So if you've beencontributing all along and you now have $150,000 in your TFS, a in 2024, andyou withdraw that full amount. Again, come January 1st, 2025. You'll be able tohave that entire $150,000 back to you as contribution room, plus the additionalannual contribution that everyone else gets. Now as you can see. This can causesome confusion on what your [00:05:00] limitmight be.

[00:05:00] So it's important that you not just your advisoror your, or CRA. But you keep on top of your contribution limit.

[00:05:07] As you will be charged a penalty tax. If you endup over contributing, like I mentioned before, this is why it definitelycomplicates things by having multiple accounts, something innocent, likeopening a TFSA at the bank to reduce your monthly service charges.

[00:05:22] Like one of the big banks likes to promote, canlead to having a small account that you forget about and end up overcontributing to. You can find your contribution limit. By accessing your CRAaccount, which will include a link to register for in the show notes. If youdon't already have one. Just visit retirereadypodcast.com and go to the episode8 page. You can also ask your accountant.

[00:05:46] And sometimes if you're lucky, you can find it onyour tax assessment. But that's the document that CRA sends you after they'veassessed your tax return, but that's the less likely way to go. Any overcontributions are taxed [00:06:00] at a 1% permonth penalty. So again, it's important to keep on top of your limit. Okay, soyou can see the huge benefit of the TFSA, the flexibility, and the plan toallow tax-free growth. That could be used for any goal. That's why I calledthis episode, the Swiss army knife of investing.

[00:06:16] The TFSA can be used for many different purposes.It can be used as a savings account, which I feel like a lot of people have.Just by default done and due to the name, gone with it. It can be used for your rainy day fund. Saving for a big purchase, like a car or a house. You can use it as a retirement account or just a general investment account. In terms of investment options. I just like the RRSP, there are many, it can sit in cash, which normally doesn't earn much if any interest, but is accessible to you. You can invest in a high interest savings accounts, guaranteed investment certificates, otherwise known as GICs or term deposits.

[00:06:53] There are mutual funds, index funds, stocks, bonds exchange, traded funds, or ETFs [00:07:00]cryptocurrency through ETFs. Even again, your own mortgage can go inside a TFSA. That option. Is very limited. On who provides that and just like theRSPM. I'm not saying you should hold these things in your TFSA, but you can itall depends on you, your goals and your tolerance for risk and trying to earnhigher returns. There are some things that you can't hold it in a TFSA,otherwise known as non-qualified investments, which includes investments suchas physical, real estate or land. General partnership units and cryptocurrencyheld outright. These non-qualified investments are taxed equal to 50% of thefair market value at the time that it was bought. Or that it becamenon-qualified and the annuitant or plan holder is also liable for the a hundredpercent advantage tax on the non-qualified investment.

[00:07:48] If this income is not withdrawn promptly. So becareful to do your research before you buy or check with your financial plannerto ensure. That investment could be held in that account. Another [00:08:00] advantage of the TFSA is the ability toname a beneficiary. By naming a beneficiary of the proceeds of the TFSA. As ofthe date of death, low tax-free to the beneficiaries, bypassing any probatefees. In the case of growth within the TFSA after the date of death, this willbe taxable in the beneficiary's hands. It's important for those with a spouseor a common law partner, to name them as the successor annuitant, as this willallow the spouse or partner to receive the full account value. Basically bydoing this, the deceased account holders name drops off the TFSA account. Andthe living spouse's name is now added. Either way the spouse will receive theTFSA if they named them as beneficiary or as a success or a new attent, but bynaming your spouse or partner as the successor holder, they basically receivethe funds and they will remain in the TFSA until needed.

[00:08:50] And that sounds a little confusing. Let me giveyou an example. Let's say both my wife and I have accumulated a hundredthousand dollars each in our TFSA's. Having fully used our [00:09:00] contribution room, plus a little bit ofgrowth for nice round numbers. If I were to pass away, having left her as asuccessor holder. She would then have a total of $200,000 in the TFSA orpreviously held a hundred thousand TFSA account and the a hundred thousand thatwas mine, but is now in her name. , if I hadn't named her as a successor holderwith the exact same scenario, she would only have a hundred thousand in theTFSA and the additional hundred thousand dollars that would be non-registeredas the funds would come out of the TFSA paid to her as the beneficiary, but shewouldn't have any contribution room left.

[00:09:34] So would have to invest those funds in a taxablenon-registered account. So just by making your spouse or common law partner,your successor holder, you could save them a lot of money in taxes. And theyget to keep this contribution room. So in the example, I just mentioned. Wherethere's now $200,000 in the surviving spouse's TFSA, let's say they actuallyneeded some of those funds and withdrew the full $200,000 out following January[00:10:00] first of the next calendar year,they get that $200,000 of contribution room back. Okay. So let's just summarizethe tax-free savings account is a registered investment count that you don'tpay taxes on the growth or interest. You can withdraw tax-free and the amountyou withdraw is added back to your contribution, limit the following calendaryear, but make sure you keep track of your contribution limit and make sureyour name, a beneficiary on the account. Okay. I think that covers everythingfor this time around. Once again, be sure to click that follower subscribebutton, please email me at info at retirereadypodcast.com. With any questionsor ideas for future topics, you can view the resources and links I talked aboutin this episode. And find the show notes by visiting retire, readypodcast.comand going to episode 8 page. You can also subscribe to the wake-up semi-monthlynewsletter by visiting the Awaken Wealth site, which is awakenwealth.ca. Besure to check back in two weeks for the next episode where I'll cover the bigquestion on these accounts of. The RSP and the [00:11:00]TFSA, which is better for you.

[00:11:02] Thanks again for joining me today and I lookforward to seeing you back for the next episode.