All About The TFSA

How it Works

The Tax-Free Savings Account (TFSA) was introduced on January 1, 2009. This program enables Canadians to save taxes on their investment income. The flexibility of the TFSA makes it effective for savings goals such as home purchase, renovations or travel, but it can also complement the longer-term savings many Canadians have previously managed with their RRSPs.

Eligibility

The TFSA is available to Canadian residents 18 and older with a valid Social Insurance Number. Generally, investments that are RRSP-eligible such as mutual funds, GICs, savings accounts and publicly traded securities can be held in a TFSA.

Tax-Free Income

Investment income earned in a TFSA will be tax-free, regardless of whether it is interest, dividends or capital gains. This is distinct from RRSPs, where income tax is simply deferred.

Contributions

The maximum contribution limit for 2009—2011 is $5,000 per year. Contributions are not tax-deductible. This limit is the same for every qualifying individual, and unlike an RRSP, the limit is not dependent on earned income. Under the TFSA, unused contribution room can be carried forward indefinitely. Someone who chooses not to make any contributions to a TFSA for the first 10 years would accumulate $50,000 in contribution room (assuming the annual limit remained $5000/year). There is no upper age limit to contributing to a TFSA, unlike an RRSP which must be wound down after age 71.

Withdrawals

Because contributions are made with after-tax income, withdrawals from the plan are tax-free. Plus, withdrawals from the plan (principal and income) 'add back' an equivalent amount in contribution room available the following year. If a TFSA holder dies, TFSA assets can be transferred to a spouse without impacting the recipient's contribution room.

Effect on Government Benefits

Income generated under a TFSA and amounts withdrawn are not included in determining eligibility for income-tested benefits and credits such as the Canada Child Tax Benefit, Old Age Security, GST Credit or Guaranteed Income Supplement.

TFSA or RRSP?

Because of their tax-advantaged status, funds placed in TFSAs and RRSPs will generate higher after-tax returns than investing in non-registered accounts, particularly for interest bearing investments such as GICs, bonds or savings accounts, which attract the highest marginal tax rates.

To help savers determine how the TFSA will benefit their particular circumstances, the federal government has placed a TFSA calculator on its website at www.budget.gc.ca/2008/mm/calc_e.html.

While there are situations when a TFSA may yield better long term results than an RRSP for retirement savings, generally the TFSA complements savings under an RRSP. Here are some members that a TFSA may appeal to.

High-Income Earners

High income earners who have maximized their RRSP contributions, and are looking for another investment vehicle that shelters income from tax will benefit from the TFSA.

Retirees

Because it has no upper age limit on making contributions, seniors can continue to grow their tax-free income under a TFSA. They do not have to collapse their plan, as with an RRSP, and move their funds to a retirement income option such as a RRIF, where the funds are gradually taxed. For those who already have a RRIF, the TFSA can be used to shelter withdrawals which are not needed. And, as mentioned, TFSA withdrawals and earnings do not affect means-tested programs such as OAS.

Conservative Income Investors

Those who prefer to save using savings accounts, GICs, bonds or other interest-bearing instruments will do substantially better tax-wise under a TFSA than by keeping their funds in a non-registered account.

Workers with Pension Plans

The TFSA can help the individual offset RRSP contribution room lost from pension adjustments.

Short-Term, Goal-Oriented Savers

While the ability to contribute up to $5,000 is an obvious benefit under the TFSA, a more valuable feature for many will be the account's liquidity. The ability to shelter funds from tax, withdraw and then replace funds in a subsequent year as needed without affecting contribution room, makes the TFSA a perfect tool to save for a variety of shorter term objectives, such as:

• Down payment for a home purchase
• Home renovations
• Emergency funds
• Travel
• Vehicle purchase
• Educational expenses

Homeowners and Empty Nesters

In the future, homeowners looking to downsize will be able to use their TFSA to shelter proceeds of a home sale from future taxation. Although a principal residence can be sold tax-free, the proceeds once reinvested in non-registered accounts would begin to generate tax.

Small Business Startups

Those looking to start a business can use the TFSA to grow their seed capital tax-efficiently, and also use the account as collateral for a business loan. Your deposits are safe and secure with insurance provided by the Deposit Insurance Corporation of Ontario for up to $100,000 for each RRSP and TFSA contract.

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