Products

Tax Free Savings Accounts (TFSA)

A new way to save

Starting in 2009, Canadians will have a new way to save with a Tax-Free Savings Account – a flexible, registered general-purpose account that will allow Canadians to earn tax-free investment income. The TFSA was introduced in the 2008 federal budget as an incentive for Canadians to save. It is the first account of its kind in Canada, and the government is calling it the single most important personal savings vehicle since the introduction of the Registered Retirement Savings Plan in 1957. It is estimated that, in the first five years, over 75% of the benefits of TFSA savings will go to individuals in the two lowest income tax brackets, with seniors expected to receive one-half of the total benefits provided by the TFSA.

What is a TFSA?

An account where contributions are made with after-tax dollars and withdrawals are tax-free. This means that money can be earned in the account and withdrawn at any time without being taxed.

Who is eligible to contribute to a TFSA?

Anyone over the age of 18 – even those without an income, or those over the age of 71, who are ineligible to contribute to an RRSP.

How does it work?

You can save up to $5,000 every year in a TFSA. The $5,000 annual contribution limit will be indexed to the Consumer Price Index and rounded to the nearest $500. For example, with a 2% rate of inflation, the first increase to $5,500 would occur in 2012.

TFSAs can hold the same investments as registered accounts, such as mutual funds, segregated funds, stocks, bonds, and GICs.

Any amount withdrawn from the account is automatically added back to your contribution room for the following year. Unused contribution room can be carried forward indefinitely to future years.

TFSA versus an unregistered account

Capital gains and other investment income earned in a TFSA are not taxed. So, if you contributed $200 a month for 20 years to a TFSA instead of a non-registered account, you would enjoy a total tax savings of $11,045.

Assumes a $200 monthly contribution for 20 years, a 5.5% rate of return and an average tax rate of 21%. Source: Government of Canada, 2008 budget.

Is it better to contribute to a TFSA or an RRSP?

While the two savings plans have different features and benefits, they are designed to complement each other. Generally speaking, whether it is better to contribute to a TFSA or an RRSP depends on two variables, namely your tax rate when you contribute funds and your tax rate when you withdraw funds. If you expect to be in a lower tax bracket when funds are withdrawn, an RRSP is probably a better investment. If you expect to be in a higher tax bracket when money is withdrawn, a TFSA may be the better choice. However, each individual situation is unique and other factors may come into play.

If investment growth is tax-free for both TFSAs and RRSPs, what are the differences?

An RRSP is primarily for your retirement savings, while a TSFA is for other investments and savings.

Contributions to an RRSP are tax deductible and reduce your taxable income, while contributions to a TFSA are not deductible.

Withdrawals from an RRSP are added to your income and taxed at your current rate, while TFSA withdrawals are tax-free.

You must convert your RRSP to a RRIF by age 71 and withdrawals after that time are mandated according to a schedule based on your age. There is no similar requirement for TFSAs.

For RRSPs, once a contribution is made, that contribution room is "used up". With TFSAs, the amount of a withdrawal is automatically added back to the contribution room.

What are the other benefits of a TFSA?

Income earned in a TFSA and withdrawals do not affect your eligibility for income-tested benefits, such as Old Age Security, Guaranteed Income Supplement and the Canada Child Tax Credit.

You can provide the funds for your spouse to contribute to their account and the assets in your account are transferred to your spouse upon death without tax implications.

Income attribution rules don’t apply, so contributions can also be provided to a spouse or an adult child for their contribution to their account. (In simple terms, income attribution occurs when income earned from money loaned to a spouse or child is attributed back to the lender, who is then taxed on that income.)

For those who have maximized their RRSP contributions, or those with employer pension plans who may not be allowed to contribute to an RRSP because of a large pension adjustment amount, a TFSA can supplement their savings on a tax-assisted basis.

TFSA Strategies

For short-term financial goals, you can use the TFSA to shelter interest income. For clients with a longer-term horizon, you can use the TFSA to shelter capital gains and dividend income.

1. If you currently own an Income Plan (such as a RRIF; LIF or LRIF): consider a TFSA to shelter income or capital gains on RIF/LIF/LRIF payments rather than depositing them to a Non Registered Open investment account.
2. If you hold an RESP or have savings for their children: A TFSA can be used as a supplement to RESPs with more flexible solution to save for your children or grand children’s education and in doing so eliminate the requirement to report interest and dividend income that would normally have to be reported in the more traditional In Trust Accounts currently used.
3. If your have contributed the limit to their RRSP: A TFSA will allow you to shelter additional income or capital gains and still provide you with access to a selection of funds.
4. This ability to deposit to your spouse or common law spouses TFSA becomes an important strategy in creating lower taxes as a consequence of being able to income split with a lower income spouse without triggering attribution to the higher income earning spouse.

For a more detailed look at TFSAs download a PDF file put out by Canada Revenue, provided here.