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What is an IRA and Why You Must Care?

Guest Post: Author J.D.

IRA

Individual Retirement Account — What is an IRA?

The technical term, according to the Internal Revenue Service, is an Individual Retirement Arrangement, though it is more commonly called an Individual Retirement Account.

An IRA is simply a holding account. It’s a label. The difference between an IRA and an ordinary investment account is twofold:

  1. Your contributions to your IRA may be deductible for income taxes. (More details below.)
  2. All the gains (dividends, interest, and capital gains) accumulate untaxed as long as they stay in the account.

When you open an IRA, it contains nothing. It’s like a bucket — it’s just a place for you to put something — and what you place in your bucket are investments.

For example, you might buy stock through your retirement account or maybe government bonds. Some people use their IRAs to buy real estate; and some simply let their cash sit there, earning interest, just as it would if it were deposited in the bank down the street.

Smart people mix things up over time. Their buckets may contain a combination of stocks, mutual funds, bonds, and real estate. But they don’t have to be diversified at all. Your IRA can contain a single index fund if that’s what you want to do.

Point to remember: An IRA is not an investment — it’s a place to put investments.

What is the benefit of an IRA?

The primary benefit of an IRA is that the returns on an investment are not taxed.

Untaxed, the gains earned in an IRA compound much faster compared to an ordinary investment account where what you earn is taxed every year.

In addition, depending on the type of IRA you set up, either your withdrawals or your contributions are not taxed. Over your lifetime, a tax-favored personal savings arrangement, or IRA, can add tens of thousands of dollars to your balance which you may not have had otherwise. It’s a benefit the federal government offers workers to encourage them to save for retirement, and the advantage is significant enough that it shouldn’t be overlooked.

Types of IRAs and their tax advantages

There are two major types of IRAs — a traditional IRA and a Roth IRA. In order to understand the difference, let’s first step back and look at a normal investment account, i.e., one with no tax advantages.

Normal Investment Account (no tax advantages)
When you use a non-retirement account, you invest post-tax money, meaning that you have already paid taxes on that income and you invest some of what is left over after taxes. Depending on how you invest, you may also be taxed on the interest, dividends, and all other gains along the way. You will also be taxed on any appreciation when you sell your investment.

As compared to a normal investment account, investing through an IRA has three different tax implications:

Traditional IRA – With a traditional IRA, you can deduct the money you invest from that year’s taxes, but you will pay taxes on any withdrawals you make from the account.

  1. Your contributions (i.e., the money you invest) will be tax-deductible.
  2. All gains (i.e., interest, dividends, and capital gains) will not be taxed as long as the money remains in the account.
  3. When you withdraw the funds after age 59 ½, you will pay normal income tax on the amount you withdraw.

Roth IRA – With a Roth IRA, you invest money that you have paid taxes on, but your withdrawals are not taxed.

  1. Your contributions are not tax-deductible.
  2. All gains (i.e., interest, dividends, and capital gains) will not be taxed as long as the money remains in the account.
  3. When you withdraw the funds after age 59 ½, you will not pay income taxes on the amount you withdrawal.

We will discuss when it makes sense to choose one or the other in a following post. For now, all you need to know is the primary difference between the two major types of IRAs.

In addition to the two types of IRAs, you can also open an Individual Retirement Annuity account. In general, those are structured like conventional IRAs, but there are limitations as to who the beneficiaries might be. The premiums have to be flexible in order to allow for lower limits in future years and count toward the IRA contribution limit. In other words, it’s an IRA investing in a specified investment vehicle (annuities), but it has to be in a separate account.

IRA restrictions

Below are a few general limitations. You can get full details, written in clear language, from the IRS website by typing “590-A” in your favorite search engine. Chapter 1 will deal with traditional IRAs and Chapter 2 with Roth IRAs.

1. Not everyone can open an IRA account. In creating IRAs, the government specifically intended them for people who work for a living. Having a job, therefore, is the number one requirement to qualify for an IRA. Very wealthy people or retirees who live off their investments can’t open one. Once you do open an IRA account, you can keep it as long as you live.

2. There are contribution limits. For 2015, your total contributions to all of your traditional and Roth IRAs cannot be more than $5,500 — it’s $6,500 if you are 50 years of age or older — or your taxable compensation for the year, if your compensation was less than this dollar limit. (These amounts change annually, so it’s worthwhile to check the Form 590-A website referred to above.)

  • The IRA contribution limit does not apply to 401(k) rollover contributions and qualified reservist repayments.
  • For married couples, each spouse figures his or her limit separately, using his or her own compensation. This is the rule even in states with community property laws.

3. You can contribute to an IRA even if you contribute to a 401(k) or similar retirement plan at work. However, once your income goes over $60,000 (single) or $96,000 (joint), limitations kick in. The IRS Form 590-A web page spells out the various scenarios clearly with two tables (Table 1-2 and Table 1-3 if you’re looking for them).

If neither you nor your spouse has a work retirement plan, there is no reduction in your contribution limit.

4. There is an annual cut-off date. You can’t make contributions for a given year after April 15 of the following year. You are not obligated to make a contribution every year, but you can never catch up once you have passed the cut-off date.

5. Your IRA can’t invest in things that are under your control, like your business. The restrictions are few — you can, for instance, invest in real estate — but as a general rule, the things you invest in cannot be connected with you (like your home or your business). You also can’t sell property to it or buy property for your personal use.

6. You can’t borrow from your IRA or use it as security for a loan.

7. Your IRA can’t invest in collectibles, with the exception of gold coins minted by the U.S. Treasury.

When you engage in what the IRS calls prohibited transactions, your IRA will be reclassified as a regular account and you will be taxed as if you made a complete withdrawal on the first day of the year.

Where to open an IRA

Because an IRA is technically just another investment account, thousands of institutions that offer investment accounts also offer IRAs. Each has its advantages and disadvantages.

  • Many banks and credit unions offer IRAs, but they may only allow the money to be used for certificates of deposit or money market accounts.
  • Big-name mutual fund companies like Vanguard are great places to open an IRA, but they often require a minimum initial investment of several thousand dollars and provide a limited universe of investment choices.
  • Discount brokerages like Sharebuilder and E*trade allow new investors to begin saving for retirement with no minimums, and they usually have smaller fees or no fees at all.

There is no one right place to open an account. You will need to search for a place that is good for you.

Questions to ask as you research where to open an IRA:

  • Is there a minimum initial investment?
  • What fees are assessed to the account?
  • Does the company offer automatic contributions?
    • What are the limits?
  • What investment options are available?
    • Stocks?
    • Mutual funds?
    • Real estate?
  • Is it possible to download statements automatically into Quicken?

Remember: The perfect is the enemy of the good. It is far better to open a Roth IRA now through any provider than it is to delay because you are worried about finding the very best place. Do your research. When you find a place that meets your requirements, open an IRA. Don’t fuss and fret, worrying about whether or not it really is the best choice. Find a good choice and go with it.

Conclusion

Don’t be afraid of IRAs. With a little homework you can add these valuable accounts to your retirement strategy.


1 comment on “TFSA Contribution Limit Withdrawals – 2019”

TFSA Contribution Limit Withdrawals – 2019

tfsa-limit

Last Updated: 17th February, 2019

TFSA Contribution Limit Withdrawals

What is a TFSA?

It is funded using tax-paid money. This means that you do not get any rebate on tax when you contribute to your TFSA. The primary benefit is tax free profits, with no future taxation on withdrawals. This is unlike an RRSP where tax paid is effectively refunded when you contribute, and then tax is later assessed when you withdraw, ideally at a lower rate of tax. The benefit of a TFSA is much more straight-forward – paying no tax on growth is better than paying tax. Extracting and maximizing benefits from an RRSP can be a bit more challenging to manage due to the fact that your tax rate in the future is effectively unknown. This makes contributing to your TFSA an easy choice when you have the room available and aren’t sure if you should be using your RRSP at the time.

The benefit to be obtained from a TFSA is capped by what is known as the “contribution limit”. You may only contribute a certain amount to your TFSA. This means the amount of investments/savings that you can shield from tax is limited by the contribution limit. It is best to maximize your use of this benefit by contributing as much as possible to your TFSA before saving/investing in any taxable accounts.

Who can open a TFSA?

Per the CRA: “Any individual who is 18 years of age or older and who has a valid social insurance number (SIN) is eligible to open a TFSA.”

Source: https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/tax-free-savings-account/who-open-a-tfsa.html

Note that non-residents or those who were previously/will be a non-resident have special rules regarding the calculation of contribution room – refer to this link: https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/rc4466-tax-free-savings-account-tfsa-guide-individuals/tax-free-savings-account-tfsa-guide-individuals.html#P44_1116

TFSA Limit / Withdrawals

Generally the calculation of a particular years contribution limit is as follows:

  • your TFSA dollar limit plus indexation;
  • any unused TFSA contribution room from the previous year; and
  • any withdrawals made from the TFSA in the previous year.

Source: https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/tax-free-savings-account/contributions.html

In effect this means unused room is carried forward, and withdrawals are added back to the next years contribution room. Therefore you’re always free to use the TFSA since if you need the money for some other purpose you can withdraw the funds, use the money, and get the room back for later re-use.

“The TFSA dollar limit plus indexation” is not calculated by you. It is a prescribed number each year (Currently $5,500). You only accumulate TFSA room so long as you are resident, and are older than or will turned 18 during the year. You accumulate this room regardless of whether you have filed an income tax return (unlike the RRSP which requires a tax return filed to calculate the room). Non-residents should look to guidance on the linked TFSA guide above.

Your contribution room is calculated across all accounts – not per TFSA account. You may have multiple TFSA accounts at different institutions, but you must ensure that your total contributions across all accounts is not beyond the limit.

Here are some examples of the TFSA room calculation: https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/tax-free-savings-account/examples-tfsa-contribution-room.html#xmpl2

Investment Types

A TFSA account is any account with the designation as a TFSA account. This means a TFSA goes beyond just “savings accounts”. You can have a TFSA account at a variety of institutions and it can hold cash, mutual funds, stocks (except in some circumstances), bonds, GIC’s, and even (in limited circumstances) small business corporation shares.

Source: https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/rc4466-tax-free-savings-account-tfsa-guide-individuals/tax-free-savings-account-tfsa-guide-individuals.html#P44_1121

Gains/Losses in the TFSA

Gains earned in a TFSA are not subject to taxation. On the other side, losses in your TFSA are denied from being offset against any taxable gains.

Source: https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/rc4466-tax-free-savings-account-tfsa-guide-individuals/tax-free-savings-account-tfsa-guide-individuals.html#losses_incurred

Slips, and reporting your TFSA on your tax return

So long as you have not over-contributed to your TFSA you are not required to report your TFSA contributions, withdrawals, or incomes. You do not need to fill out anything when filing your taxes. Your TFSA information (summary of activity during the year) is submitted by the institution who created the account to the CRA.

How to find your contribution limit

You can find your contribution limit for a particular year at: * CRA My Account; * MyCRA at Mobile apps; * Represent a Client if you have an authorized representative; or * Tax Information Phone Service (TIPS) at 1-800-267-6999.

Source: https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/rc4466-tax-free-savings-account-tfsa-guide-individuals/tax-free-savings-account-tfsa-guide-individuals.html#P44_1120

Your Contribution Limit is updated after each year, but it may take a while after year-end for your contribution limit to be properly updated at the CRA. The CRA needs to wait for all of your institutions to file your information, and then it takes a while for the CRA to update their systems to reflect the new limits.

Generally speaking it is a good idea to track what you would expect your TFSA limit to be to ensure that all institutions have properly filed the activity for the year. Any errors by your institutions are your own responsibility to resolve in order to avoid penalties. You can call the CRA for an activity summary if you need the detail of activity filed with them in order to reconcile your TFSA limit. If you believe there is an issue with what one of your institutions filed then contact that institution – and then contact the CRA if they are unable to help.

Source: https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/rc4466-tax-free-savings-account-tfsa-guide-individuals/tax-free-savings-account-tfsa-guide-individuals.html#p3021_26370

Day Trading in the TFSA

This is nearly impossible to comment on in a wiki article, however it needs to be at least mentioned. The issue with day-trading in your TFSA stems from the following rule – you are prohibited from using the TFSA to shield the incomes of a business activity (as a business is not an eligible investment for a TFSA). In taxation the term “business” has a specific definition that alludes to some general factors to determine what is business activity. Generally speaking passive investing, or investing through a normal adviser, or long-term buy and hold investing, would not be considered a “business activity”. However, frequent (day) trading or highly speculative trading (and the research and other activities that come along with this) ends up being seen by the CRA (and our taxation laws) as a business activity. The CRA is increasingly targeting individuals with high profits/high activity for audits of their TFSA accounts. It is NOT recommended to day trade or keep highly speculative investments in your TFSA. AGAIN, this is FAR from a detailed explanation of the issue.

Effects on Credits

As withdrawals from a TFSA are not considered to be income you can freely withdraw funds from your TFSA without concern for losing certain income based credits such as the WITB/HST/CCB or other amounts.

Source: https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/rc4466-tax-free-savings-account-tfsa-guide-individuals/tax-free-savings-account-tfsa-guide-individuals.html#P44_1117

Foreign funds

Foreign funds be held in a TFSA account (such as US dollars and US dollar denominated investments), but for the purpose of reporting the usage of contribution room/withdrawals the amounts will be converted to Canadian dollars.

Source: https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/rc4466-tax-free-savings-account-tfsa-guide-individuals/tax-free-savings-account-tfsa-guide-individuals.html#p3021_26419

Death of a TFSA Holder

I can only provide a link in this wiki article for this issue: https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/rc4466-tax-free-savings-account-tfsa-guide-individuals/tax-free-savings-account-tfsa-guide-individuals.html#P44_1119