How do I use my TFSA?

So I set up a TFSA with my bank today and plan on transfering funds into it with the intention of investing them.

My question is, how do I go about making sure I am using this account correctly so i don't get dinged at tax time?

From the canada revenue agency website:

Q.9 What kind of investments could I hold in my TFSA?

A.9 A TFSA would generally be permitted to hold the same investments as a registered retirement savings plan. This would include mutual funds, publicly traded securities, GICs, bonds, and certain shares of small business corporations

http://www.cra-arc.gc.ca/gncy/bdgt/2008/txfr-eng.html#q9


Does anyone have their tfsa linked directly to their trading account?

Any insight would be great.

Cheers!

On the CRA website, they have a functionality called "My Account" I have been recommending this to those people who I prepare taxes for, since it contains a lot of important information (prior year returns, RRSP & TFSA limits, etc...). You can also make changes (to your tax returns, address, ask questions, etc...) Also, your tax preparer can register for a special ID called a "Rep ID", which you can use to set them up to access your account (you can restrict them to view only or allow them to trasact on your behalf as well. I have set this up for a number of people to allow me to access their information and file adjustments on their behalf and enjoy it greatly. Overall, a highly worthwhile CRA service. The catch is that it is a pain to set up initially with the user ID and password, which they will mail to you several weeks after online registration. Still, in my opinion this is worth it.

Once you have access to the above, you can no for sure your TFSA limit (it seems to be updated once per year - not sure if it is in january or on filing time around april). If you have NEVER used the TFSA before, then you will have $10,000 in contribution room. This amount will rise to $15,000 in January 2011, as the contribution room is currently rising by $5,000 each year.

You then need to set up the TFSA with the bank. In the past, many banks were only offering High Interest Savings Accounts for the TFSA, but I think they have all come around to the idea of using it like an RRSP now. Make sure you are requesting a self-directed TFSA to trade stocks rather than the High Interest Savings Account kind. Once you have the account set up and have contributed a balance, you should be good to go. I found out that at CIBC, you can just deposit a cheque at the teller directly into your trading accounts, and a phone call to the discount brokerage will get that money moved around to different accounts after it is in.

You are probably aware that whatever you put in does not get a tax refund like an RRSP contribution, however, whatever you take out does not get taxed either. I set up an article before in the tax section comparing RRSP to TFSA, and in my opinion, TFSA is absolutely without a doubt the way to go unless you are in special circumstances (very high tax bracket now, and expect to be in very low tax bracket when you retire). Anyway, ask any questions on that topic in the other thread.

1) Whatever you contribute, has no tax effect except to reduce your contribution room.
2) Whatever income earned inside of the TFSA has no tax effect
3) Any withdrawls (including income) from the TFSA have no tax effect and also add back to your contribution room IN THE FOLLOWING YEAR.

You cannot just contribute and withdraw the full $10,000 in and take it out as many times as you like during the year. Once you withdrawl, you do not recover that contribution room until January of the following year.

If you contribute more than the $10,000, you will face a penalty. Don't have any info on that, but should be able to find out on the CRA site. No one is tracking your contribution room for you when you go to contribute, so don't expect the bank to notify you if you are going over the limit.

You can contribute stock from non-registered account into TFSA. If you contribute at a gain, you will trigger the capital gain upon contribution (it is considered like you sold the stock and repuchased it inside the TFSA at the same price). However, a special and incongruent rule is if you contribute it when you are at a loss, you cannot claim the loss on your taxes. Any transfer in of a US stock will be assigned a Canadian value in your account that you will use to determine remaining contribution room.

While any income in the TFSA is not taxable, likewise any losses inside the TFSA cannot be claimed (so don't lose money). Losses will also reduce you contribution room if you decide to withdraw from the TFSA at a loss. For example, you put in $10,000 and lose $1,000 and take out $9,000. Your contribution room for next year will be $9,000 (plus the $5,000 increase per year).

In my case, with CIBC, I got a terrible deal on trading commissions inside the TFSA, so make sure to confirm the treatment with your brokerage. It was an expensive lesson to learn after the fact. In my case, I did my trading outside of the TFSA, and then called the brokerage to transfer the stock into the TFSA (which they will do for free). This allowed me to get around the high commissions they were charging inside the TFSA, and I cleared it with the broker that this was completely legitimate.

Once you have the funds or stock in your TFSA, you should be able to trade it like any other account. Again, verify the commission structure before you start trading.

The final strategy is with regard to taxation. Considering for example that Interest income is 100% taxable (at 30% tax rate), Capital Gains are roughly 50% taxable, and dividends are roughly 45% taxable (US dividends are considered like intererst), it would make most sense to put the investment type which will attract the most tax inside the TFSA first. However, like an idiot, I jumped into the TFSA High Interest Savings Accounts when they first came out rather than waiting for the banks to offer self-directed trading accounts. Yes, this was the most tax efficient choice, but the income was very little, so ultimately I realized it just did not make any sense and I would be better off to shelter capital gains just because (in absolute $) there would be more taxable income sheltered even if it was taxed a lower rate. This also increases contribution room by having higher absolute income growth in the TFSA. But if you have two dividend paying stocks paying out the same rate, one in Canada, and one in US, I would recommend to shelter the US stock for tax efficiency. Likewise, sheltering US stocks will also protect you from taxable exchange gains and associated reporting requirements.

I like TFSA, and generally don't know how long it is going to last. Obviously the CRA can't allow all investment income to go untaxed, so eventually they are going to freeze the contribution room and/or cancel the program entirely. Take full advantage of it while it lasts.

Good info Max!

I did make a mistake when I set up my account. I opened up a cash TFSA account with scotia bank. I needed to open up a TFSA account with scotia iTrade to be able to use it for market trading.

I have an appointment with the bank to "transfer" the TFSA account over. If I just opened up another TFSA and deposited the money from one to another it would be considered another contribution.