Tax Free Savings Account
The 2008 Federal Budget introduced a big treat for investors by proposing a brand new savings plan that allows us to save money for retirement, or any other purpose, on a completely tax free basis.
Who is Eligible?
Effective 2009, any Canadian resident who is 18 or older can make a deposit to a TFSA.
What are the Contribution Limits?
The initial year’s contribution limit is $5,000, with future annual limits indexed to inflation, and rounded to the nearest $500.
Like a Registered Retirement Savings Plan (RRSP), if you don’t contribute the maximum amount each year, the unused amount is carried forward so you can use it in the future. However, unlike a RRSP, if you withdraw money from your TFSA, the amount you take out will be added back to your contribute room, so you can contribute it again in the future.
Be careful though. If you contribute more than your limit, you will have to pay a penalty tax of 1% per month on the excess amount.
What are the Tax Advantages?
Deposits to a TFSA are not tax deductible, but here’s the big advantage: all your income, capital gains, and dividends are not taxable.
Also since earnings (and withdrawals) are not included in your taxable income, your income tested government credits and benefits like Old Age Security benefits, Old Age Tax Credit, GST credit, subsidized nursing home care, Guaranteed Income Supplements, etc. will not be affected.
What Can You Invest In?
Qualified investments for a TFSA are the same as for RSP investments, including mutual funds, public securities, bonds, term deposits, etc.
Can I borrow to make my deposits?
Yes. Also, investments in a TFSA can be used as collateral for a loan. However, since the income earned on a TFSA is not taxable, any interest you pay on money borrowed to make a TFSA contribution is not tax deductible.
Income Attribution
Normally, if you give money to your spouse or common law partner, income earned on that money is taxed back to you. However, if your spouse or common law partner deposits the money into a TFSA, this does not apply.
What happens upon death?
On death, most assets are considered to be disposed of at fair market value for tax purposes. If your assets pass to your surviving spouse or common law partner, then the tax is deferred.
With a TFSA, there is no deemed disposition at death, but the ongoing investment income and gains will be taxable, unless you name a surviving spouse as the “successor” In that case, your TFSA will maintain its tax exempt status, and will not affect your spouse’s own TFSA contribution room.
Comparison to RRSP
So, assuming your money is limited, which do you choose? A TFSA or RRSP?
The following is a comparison of a TFSA deposit of $5,000, and an RRSP deposit of $8,881 ($5,000 net, after receiving a 43.7% tax refund). Both assume earnings of 7% for 20 years:
