The right financial plan can avoid costly tax mistakes. Unfortunately, sometimes investor’s aren’t aware they’re making bad decisions. In this post I’ll identify the biggest TFSA pitfalls and how to avoid them.
Canada’s Tax Free Savings Account (TFSA) is a popular savings vehicle. You put your after-tax money in and any capital gains, dividends, or interest earned is tax free, right? Not exactly.
TFSA – foreign investments
Yes, you can hold foreign investments in a TFSA. However, if you received US foreign dividends, the IRS will apply a withholding tax between 15% to 30%. On the other hand, if you owned a Canadian corporation no tax would be paid at all.
US persons face additional tax issues if they hold a TFSA and must pay US income taxes annually on TFSA income and capital gains. In this post we’ll focus on Canadian’s living in Canada.
Are you looking for ways to avoid paying withholding tax within your TFSA?
There are two potential solutions:
- Hold foreign dividend paying corporations in your Registered Retirement Savings Plan (RRSP) or a Registered Retirement Income Fund (RRIF). In this case, no IRS withholding tax applies because the accounts are recognized as tax-deferred accounts under the Canada-US tax treaty.
- Hold foreign dividend paying corporations is a non-registered investment account. Here, investor’s have access to the foreign tax credit and can recoup withholding taxes when filing their tax return.
Tax Tip! If a non-registered account holds a foreign investments with a cost basis greater than $100,000 at any time during the year, a completed T1135 Foreign Income Verification Statement must be completed.
TFSA – estate Planning
Potential tax consequences exist when TFSA beneficiaries are not named correctly.
A TFSA has two types of beneficiaries: 1) a successor holder and 2) a designated beneficiary.
Only an TFSA account holder’s spouse or common-law partner can be named a successor holder. A designated beneficiary can be anyone. Either can be named during the TFSA account opening process or in a will.
At all costs name your spouse as the TFSA successor holder. The TFSA account is transferred immediately upon death and contribution room is not affected and probate fees will be avoided.
Things become complicated when you don’t name a spouse as a successor holder.
In the case of a designated beneficiary, the above rules apply but the transfer must be completed during the rollover period which lasts until December 31st of the year following the accountholder’s death. Also, any increase in fair market value before the transfer to the beneficiary’s TFSA is taxable. If the exempt period ends and the TFSA hasn’t been transferred to a beneficiary, the TFSA become a taxable inter-vivos trust.
To declare and exempt contribution, you need to send the CRA form RC240 within 30 days of the contribution.
Conclusion
The bottom line is designating your spouse or common-law partner as a TFSA successor holder is the ideal estate planning solution. It’s straight forward and easy to administer. Regardless, a comprehensive estate plan is key to avoid unnecessary tax consequences.
Disclaimer: The content on this webpage is intended for informational and educational purposes only. No content on this webpage is intended as financial advice. The publisher of this website does not take any responsibility for possible financial consequences of any persons using the information in this educational content. Trade and invest at your own risk. Trade your own view.
