On November 26, the Harper government announced that starting January 1, 2013 they will increase the Tax Free Savings Account (TFSA) limit by $500 to $5500. About 30% of Canadians who have a Tax Free Savings Account max out their annual contributions, so this news should be welcomed by these TFSA maximizers.

This is the first time the government increased the TFSA contribution limit. Upon the initiation of the TFSA, the government announced that they would make the $5000 annual contribution limit indexed to inflation using the Consumer Price Index (CPI) data from Statistics Canada. The inflation amount is rounded to the nearest $500. In 2013, this is the first year that the amount exceeded the threshold, hence the increase to $5500 for the annual Tax Free Savings Account contribution limit.

Any Canadian citizen aged 18 or over is eligible to open up a TFSA since 2009. For those who have not opened up at Tax Free Savings Account yet, the amount you are eligible to contribute is now $25,500 in 2013. The TFSA is highly recommended (TFSA vs RRSP) for young individuals who are currently in a low income tax bracket and are expected to increase their income in the future.

Advantages of a TFSA

I’m most likely preaching to the converted, but some of the advantages of the TFSA include:

  • Interest, capital gains, and dividend income earned within a Tax Free Savings Account are not subject to tax;
  • Income earned in a Tax Free Savings Account does not affect the eligibility for certain federal and provincial benefits and credits; and,
  • Unused contribution room can be carried towards future years.

How Much Contribution Room?

This link will help determine how much TFSA contribution room you have.

What You Can Hold in a Tax Free Savings Account

Although the awareness is increasing that the Tax Free Savings Account doesn’t necessarily have to be a savings account, many Canadians are still using the Tax Free Savings Account as a savings account.

The types of investments that can be included in a Tax Free Savings Account include:

  • Cash (e.g. savings account)
  • Mutual funds
  • Bonds
  • Guaranteed Income Certificates
  • Equities (stocks, exchange traded funds, etc.)

Where You Can Get Money to Put in your Tax Free Savings Account

In Kind Contributions:

This is probably the easiest way to contribute to your Tax Free Savings Account because the money is already there but you will obviously have to take a capital gains hit when transferring your non-registered equities into a Tax Free Savings Account if the fair market value exceeds your original purchase price.

However, if the equity that you have in your non-registered portfolio is similar in price to what you bought it as, and you still want to hold on to it (e.g. blue chip dividend stock), it might be a good idea to consider switching it to your Tax Free Savings Account.

In addition, if the fair market value is lower than your original purchase price, you will not be able to claim a capital loss when transferring equities in-kind from a non-registered portfolio to the Tax Free Savings Account.  In this case, best to sell the stock to claim the capital loss, then contribute the cash to your TFSA.

Save It

$5500 per annum equals to about $460 a month of savings. Although it may seem difficult to do, if you automatically deduct it from your pay cheque and “pay yourself first” you probably will not notice that you’re saving a big chunk of money per month. I believe most individuals reading Million Dollar Journey have no difficulties saving the extra $42 a month difference from 2012 to 2013 Tax Free Savings Account contributions.

How to Increase your Tax Free Savings Account Contribution Room

Most people probably already know this by now, but lets say you withdraw $1000 from your TFSA that already had $20,000 in it this year. If you withdraw $1000 and then wait until the following year, you will be allowed to contribute $6500 ($1000 + $5500).

Withdrawing from your TFSA creates additional contribution room that is equal to the amount that is withdrawn, but this is only the case for deposits in future years.

Basically, this makes the Tax Free Savings Account the best thing since sliced bread, especially for those who are either already maxing out the RRSP or who are starting out and wouldn’t fully benefit from the RRSP deductions.

If you think this is too good to be true, feel free to give the Canada Revenue Agency a call yourself through the Tax Information Phone Service hotline 1-800-267-6999.

About the Author: Clare is a 20-something who lives in beautiful (but expensive) British Columbia and has been working on her frugal living skills and fighting lifestyle inflation. She works to expand her DIY investment knowledge and hopes to enjoy financial independence one day. She enjoys reading personal finance books, freelance writing, but not so much arithmetic.

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