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Contribution Room 101

What is Contribution Room all about and its Significance in the TFSA

Everyone knows that the upper limit for contributions into the TFSA in each year is $5,000.  What a lot of people are unaware of is the concept of contribution room which can actually serve to increase the maximum amount one can put into the TFSA in any given year.  The TFSA is like a gift given by the Government to people above the age of 18 years of age to encourage savings.  It would serve people well to know the laws and facts surrounding TFSAs thoroughly in order to optimize their saving and wealth accumulation.

A very important factor here is contribution room.  So, is contribution room always $5,000?  The answer is no.  Contribution room can vary depending on many factors.  They are as follows:

a) When contribution room is unused in one year.

In case the full contribution room is not availed of in any given year for one reason or another, it is automatically carried forward to and added to that of the following year.  Say an investor deposits $4,500 into the TFSA in 2009, then $500 is carried forward and added to the contribution room of 2010, making it $5,500.

b) When contribution room is exceeded in any year.

In case one deposits more than the contribution room for the year in question, there is a penalty to pay. Very few are aware of this.  They believe that the TFSA is such a simple facility that they can just invest funds and in case they step over the upper limit, then the interest on that is just not taxed.  Not so.  TFSAs would get very difficult to monitor if everyone did this.  So a penalty is levied on amounts that exceed the contribution room and this is 1% a month until the extra amount is withdrawn.  So one would do well to keep a track of the money in the TFSA and stop when they reach the maximum contribution amount for that year.

c) How to determine the TFSA contribution room for any year.

This is revealed by the Canada Revenue Agency through the Notice of Assessment or the My Account spot on their website.

d) When a contribution is made to one’s spouse’s TFSA, what is the effect?

One can contribute to one’s spouse’s TFSA and it does not affect one’s own contribution room, neither do income attribution rules apply. Income and capital gains that accrue in the spouse’s TFSA will be taxable in the hands of the spouse who owns the TFSA and not the one who invested the money.

e) What happens if one becomes a non-resident while holding the TFSA?

One is still able to hold and maintain the TFSA and no tax is attracted on earnings or withdrawals in the account. But additional funds cannot be contributed and no accrual of contribution room take place during the period when one is a non-resident.

f) Can a TFSA be opened by a non-resident?

No. TFSAs can only be opened by permanent Canadian residents (over 18 years of age).

g) Can one increase contribution room in any way.

Yes, this can be done.  Of course, luck is an element here as well.  To use an example, if one buys stocks for $5,000 in a TFSA and these appreciate in value to $14,000, to capture the additional contribution room, the investor withdraws the stocks, leaving contribution room of $14,000.  The downside?  The waiting period to re-invest is until January of the following year, thus tax-free growth is sacrificed during the interim.

h) What happens if one does not contribute at all in the year 2009.

The contribution room of 2009 is carried forward to 2010 in this case, thus making the contribution room of 2010 $10,000.  There is no time limit for carry forwards either.

i) The effect of withdrawals in any year.

Withdrawals made in one year create contribution room that is added on to the next year’s contribution limit.  So if in 2009, one invests $5,000 in the TFSA and then proceeds to withdraw $1,000, the contribution room for 2010 becomes $5,000 + $1,000= $6,000.

j) What is the contribution room if an investor has more than one TFSA?

Investors are allowed to possess more than one TFSA.  In this case, the maximum contribution limit remains the same at $5,000 across all the TFSAs and does not increase. (Unless, of course, there are some carry-forwards of unused contribution limits or room created by withdrawals in the previous year.  But the basic $5,000 remains the same)

As can be seen from the above, the concept of contribution room is very interesting and it would serve investors well to have a thorough knowledge of this. Indeed, contribution room seems to be the focal point of the TFSA. It acts as a guideline for deciding how much to invest, when to invest, when to withdraw and in what form to invest, among other decisions.


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