Another year, another $5,500. That’s how much more you can add to your tax-free savings account (TFSA), effective Jan. 1. If possible, take advantage of the opportunity. TFSAs are one of the most powerful savings tools available to us. (The RRSP is the other.)
By some estimates, almost half of adult Canadians have opened a TFSA. However, few are contributing the maximum amount. A study published last year by Investor Economics found that the average TFSA balance in mid-2012 was $7,400. At that point, anyone who was 18 or over when the program was launched in 2009 had contribution room of $25,000.
Still, the wide acceptance of TFSAs in just six years is encouraging. What concerns me is that many people still don’t understand exactly how these plans work, even though they may already have opened an account.
So today let’s test your TFSA IQ. Here are 10 questions, ranging from easy to complex. See how well you do. Answers at the end.
1. How old must you be to open a TFSA?
d) No restriction
2. At what age must a TFSA be closed?
3. How much are you allowed to withdraw from a TFSA annually without paying tax?
d) No limit
4. How much can you transfer from an RRSP to a TFSA each year?
d) No limit
5. Which of the following cannot be held in a TFSA?
a) Real estate
c) Mutual funds
d) All are eligible
6. How much is the withholding tax on U.S. dividends paid to a TFSA?
d) No tax — TFSAs are tax-sheltered
7. If your spouse/partner does not have a TFSA, how much money can you give him or her to open one without running afoul of the CRA’s income attribution rules?
8. What is the maximum number of TFSAs any person can own?
d) No limit
9. When is the cut-off date for making your 2014 TFSA contribution?
a) Feb. 28
b) March 1
c) April 30
d) No time limit
10. How long will it take the value of a $1,000 contribution to double if the average annual compound rate of return is 6 per cent?
a) Six years
b) Eight years
c) 12 years
d) 15 years
All right, let’s see how well you did. Score one point for each correct answer.
1.The correct answer is b) age 18. You start accumulating contribution room at that age even if you don’t open an account.
2. If you answered d) never, give yourself a point. Unlike RRSPs, which must be wound up at age 71, you can keep your TFSA for as long as you live.
3. The correct answer is d) there is no limit on tax-free withdrawals from TFSAs. That’s what makes these plans so powerful.
4. If you said c) you got it right. Direct transfers from an RRSP to a TFSA are not allowed under any circumstances.
5. You can hold almost any type of security in a self-directed TFSA except land and buildings. If you answered a), you get a point.
6. The answer is c) 15%. TFSAs are not exempt from the withholding tax under the Canada-U.S. Tax Treaty although RRSPs are.
7. Believe it or not, you can give your spouse $31,000 to invest in a TFSA if he or she has no plan and was 18 or older on Jan. 1, 2009. The income attribution rules won’t apply as long as the money stays in the account. So c) earns you a point.
8. The answer is d). There is no limit on the number of plans you can open although practicality suggests you should have no more than one or two.
9. Again, d) earns the point. There is no time limit for TFSA contributions.
10. It would take 12 years — answer c) — for your money to double at a 6-per-cent rate of return. If you could improve the return to 8 per cent, your money would double in nine years.
If you scored 8 to 10 points, consider yourself a TFSA genius. A score of 5 to 7 is good but anything below that suggests you need to read more about these plans before you start investing.