Avoid this trap when transferring TFSAs from one financial firm to another

Are you a TFSA accumulator?

I kind of am. I have one tax-free savings account at a robo-adviser, one at an online brokerage and one at an online bank. There may be others…

One day, I’ll probably want to follow the example of a reader who recently inquired about the correct way to transfer his TFSA. He recently sold some mutual funds he’d held for years in a TFSA at a bank, then had the money parked in TFSA savings account at the same bank. What he wants to do now is transfer the money to a TFSA at an online brokerage, where he can invest in exchange-traded funds and stocks. His question: Will the Canada Revenue Agency penalize him if he does the transfer this year?

The CRA website offers some guidance on this. Basically, you must request what’s known as a direct transfer of your TFSA to avoid the potential for taxes. You do not want to withdraw money from a TFSA to make that transfer. “If you withdraw the funds yourself and contribute the same funds to another TFSA, this transaction would not be considered a direct transfer and could have tax consequences,” CRA says.

Taxes do not apply to money withdrawn from TFSAs – tax-free is right in the name. The tax risk comes from potential to make an over-contribution when in the same year you (a) make your usual annual TFSA contribution and (b) take cash out of a TFSA account and then add it back to another TFSA, or even the same one.

This reader said he has “plenty of TFSA room,” so he might not be at risk of an over-contribution if he were to withdraw money from his bank TFSA and then move it to an online broker. Let’s face it, that’s a much quicker route than having one financial institution request a transfer of a TFSA from another. But the safer route for avoiding taxes is the direct transfer.

One last note: You don’t have to cash in investments before arranging a direct transfer to another firm. The contents of your account can also be transferred in kind, which means they’ll be transferred from one account to another. Once the assets arrive in the new account, you can sell them as needed.