Tax-free savings accounts (TFSA) offer one of the few tax havens Canadian investors enjoy.
And while many Canadians now have TFSAs — 44% according to a recent BMO Bank of Montreal study, they clearly don’t get them.
BMO found that only a third of respondents knew that mutual funds can be held in a TFSA, while the same proportion were aware that guaranteed investment certificates (GICs) are eligible.
Although it’s called a “savings” account and many commercial banks have promoted their use as such, TFSAs aren’t limited to cash or GICs. You can also invest in bonds, mutual funds or stocks – just as you can in a registered retirement savings plan (RRSP).
Whereas RRSPs offer tax deferral to a time when your income will presumably be lower, TFSAs offer tax-free gains but no immediate tax relief. This is why interest-generating investments such as GICs have been touted as TFSA appropriate – because interest generated outside of a TFSA (or RRSP) is fully taxable.
However, GICs and savings accounts aren’t garnering much of a return these days.
So should you give junior mining stocks a try? Well, that depends.
If the stocks you picks do well, you’re in for a windfall, says Liam Fitzgerald, a senior tax partner at PwC.
“You could put $5,000 worth of junior mining penny stocks in there and if they took off and you tripled your money to $15,000, that $10,000 gain is not taxed.”
Held outside of a TSFA, the realized gain on selling the stocks would be subject to capital gains tax (50% of the gain is taxed at your marginal rate).
The drawback of course, is that if your stock selection instead declines in value, you forgo the capital loss deduction you would have been able to claim had they been held outside of a TFSA.
“You have a trapped loss, you don’t get the benefit… so if you buy $5,000 worth of stocks and it becomes $2,000, you don’t get to deduct the $3,000 loss,” Fitzgerald says.
Capital losses can be carried backward three years to offset capital gains in past years (at a rate of 50% of the loss), or can be carried forward indefinitely.
So while it’s advisable to avoid putting tax-advantaged investments into a TFSA, there are no hard and fast rules.
If you haven’t opened a TFSA yet, note that you have been accumulating contribution room to the tune of $5,000 a year since TFSAs were introduced in January 2009 (assuming you’re a Canadian resident and were 18 or older for the past three years). That means you could open a TFSA and put up to $15,000 in an account right now – or $20,000 next year.
One other note about: there’s been a lot of confusion regarding over-contributions to TFSAs, which are subject to a penalty tax of 1% a month on the excess contribution.
Just make sure that if you withdraw money from your TFSA, you wait until the next year to put it back.
“Essentially, once you reach your contribution limit for the year, you cannot reinvest or return money that has been withdrawn from your TFSA in the same year,” says David Heatherly, vice-president, BMO Bank of Montreal. “However, that withdrawal amount gets added to the contribution room available in the year following.”