07/07/2015 08:22 EDT | Updated 07/07/2016 05:59 EDT

Canadians Are Still Stumped by TFSAs

Male hand putting coin into a piggy bank

Canadians may be able to save more in their Tax Free Savings Accounts (TFSA) but most are still confused by how the account actually works

Tax-Free Savings Accounts (TFSA) seemed like a simple concept when it was announced in 2009. Canadians over the age of 18 were allowed to save up to $5,000 per year in a TFSA. Banks and other financial institutions scrambled to offer accounts. But that year, I had a client who came and told me that he had opened a TFSA at every major bank and deposited the maximum amount. He was disappointed when I explained that it was not how it worked.

The rules are easily misinterpreted. I know several people who have been hit with overcontribution fines. It happens more often than you think. Most banks will not take responsibility for figuring out your contribution limit. You can find your TFSA contribution limit on My Account or by calling the Canada Revenue Agency. It is no longer included on your Notice of Assessment.

You are allowed to deposit up to your TFSA contribution limit into your account during the calendar year. So if you have $10,000 worth of contribution room available for 2015, you can deposit up to $10,000 throughout the year. If you withdraw money, it is added back into your contribution limit, but only after the end of the year. So using the above example, depositing $10,000 in March 2015 and then withdrawing $2,000 in August 2015 does not mean you can deposit $2,000 again in October 2015. You have to wait until the next year.

Is your head spinning yet? You are not the only one. According to a recent survey by Mackenzie Investments on TFSAs, Canadians are still confused five years later. When asked about how much money can be contributed, how often and what kind of investment options were available for TFSAs, about half of Canadians were able to correctly answer three of five questions. About half of Canadians doesn't seem so bad until Mackenzie says it is only up seven per cent from the last time they did this survey five years ago.

The same survey showed Canadians still believe that they can deduct TFSA contributions on their taxes and less than half were aware that TFSAs could include stocks, bonds and mutual funds. You do not have a standard interest-bearing bank account for your TFSA. You can invest it many ways, but you should make sure you understand the risks if you include investments in your account. There are people who have translated their TFSA contributions into sizable accounts due to savvy investments and market knowledge. But this is not for everyone.

Any money earned in your TFSA is tax-free. You do not report it on your tax return. It is all yours. And there are no penalties for withdrawing money from your TFSA. If you have an unregistered savings account or cash holdings, you will pay tax on the interest earned so it may be worth looking at a TFSA to help lower your tax bill.

Depending on your plans, a TFSA may make more sense than a Registered Retirement Saving Plan (RRSP). Though you can withdraw money from your RRSP without penalty to purchase your first home, you may have other savings goals. For example, if you want to buy a new car, you may want to save using a TFSA so the interest you earn is tax-free and there is no penalty when you withdraw it to purchase your new wheels.

Even if you don't have the funds for a TFSA right now, you should understand the options available in case your situation changes. There are times when a TFSA can make sense but you should not use it like a standard savings account. This can lead to the overcontribution penalties and more confusion. If you are thinking of opening a TFSA, find out your contribution limit and how it works. Knowing how a TFSA works before you get a notice from the CRA is always better.


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