A Warm Welcome To The TFSA

Effective in 2009, Canadians 18 years of age and over will be able to accumulate money on a tax-sheltered basis in a TFSA and ultimately withdraw the proceeds tax-free for any purpose over their lifetime. While contributions are not tax-deductible, you will acquire $5,000 of TFSA contribution room each year. In addition, the $5,000 will be indexed to inflation.

Equally important, unused contribution room can be carried forward indefinitely to future years, without limitation. For example, if you contribute $2,000 to a TFSA in 2009, your contribution room for 2010 will be $8,000 ($5,000 for 2010 plus $3,000 carried forward from 2009). One interesting twist is that you can “recontribute” amounts taken out of the plan. In other words, any amount that you withdraw in a particular year will be added to your contribution room for the following year.

The ability to accumulate investment capital in the TFSA on a tax-free basis, and pay no taxes when you withdraw all or a portion of the proceeds, will allow you to use the TFSA for many purposes. Beyond the obvious use of building a pool of retirement capital, particularly for those who have maxed out their RRSPs, we envision these plans being used to accumulate a downpayment for the purchase of a home, to save for an automobile, to set aside money for a wedding – you name it. A TFSA would also be an excellent vehicle for capital that you want to keep liquid for emergencies.

While qualified investments will be the same as for an RRSP, I can see the TFSA being an excellent vehicle for fixed-income investments (GICs, bonds, money market) to eliminate the heavy tax burden of interest income as much as possible. Or alternatively, to hold investments generating foreign dividends which do not receive the benefit of the dividend tax credit and hence are taxed at a much higher rate.

Furthermore, the income generated within the TFSA will have no impact on our income-tested benefits such as the Canada Child Tax Benefit, the Goods and Services Tax Credit, and the Age Credit, nor will it impact the clawback of Old Age Security benefits. And, if you give money to your spouse or common-law partner to take advantage of TFSA contribution room, there is no “attribution” of the income earned, as is the case when you transfer property to a spouse or common-law partner.

Here are some other TFSA details worth noting:

A TFSA plan can be transferred tax-free on death to a spouse or common-law partner as the “successor account holder”. Or, the assets of the plan itself can be transferred regardless of whether the survivor has available contribution room, and without reducing the survivor’s contribution room.
In the event of a marriage or common-law partnership breakdown, an amount may be transferred from one spouse’s TFSA to the other’s, but this will not reinstate contribution room of the transferor, nor will it impact the available contribution room of the transferee spouse.

The Canada Revenue Agency will track TFSA contribution room when you file your annual income tax return, just as they currently do for RRSP contribution room.

You can have more than one TFSA.

Capital losses won’t be deductible against capital gains.

As you read this, the question that probably comes to mind is: “How does a TFSA compare to both an RRSP and unregistered savings?” The chart and commentary on the previous page is from the Federal Budget documents. It assumes $1,000 is available for investment and details the effect of contributing to a TFSA, RRSP or a traditional unregistered savings account.

What is interesting about this comparison is that it assumes that your effective tax rate will be the same at the time you contribute and on withdrawal. In any individual situation it will be important to look at all future potential sources of income, say on retirement, e.g. pensions, non-TFSA investments, and the effective tax rates that result, in order to further analyze the pros and cons of TFSAs and RRSPs.

For example, if an analysis determines that you will have a lower effective tax rate in retirement, then the RRSP is the preferred, first choice savings vehicle. Alternatively, if you will have a higher effective tax rate in retirement, then the TFSA is a good vehicle for you. On the surface, however, it seems to me that the TFSA will be an extremely useful vehicle for most Canadians.

Kirk Polson, CFP, CLU,CH.F.C., Fee-Based Financial Planner, Polson Bourbonniere Financial Planning, Markham, ON, (416) 498-6181 or (800) 263-0120, kpolson@pbfinancial.com, http:// www.worryfreeretirement.com.

Dale’s note: The TFSA may replace or precede the RRSP as one of the best ways to save for your retirement. However, each person should crunch your numbers for the future tax effects of these investment vehicles. What investments you put in the open, registered and tax-free accounts take on even more importance now.
Canadian MoneySaver • PO Box 370, Bath, ON K0H 1G0 • (613) 352-7448 • http://www.canadianmoneysaver.ca • JUNE 2008