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TFSA: Take Advantage of a New Tax Haven - Another Way to Add To Retirement Income And Plan for Emergencies

First Posted: January 21, 2009

By Bennett Gold LLP, Chartered Accountants

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As of January 2, the Tax-Free Savings Account (TFSA) that was announced in the 2008 federal budget is available.

If you are a resident Canadian 18 years of age and older your can open a TFSA and contribute as much as $5,000 a year. You can also open a plan for your spouse, common-law partner or other family member without attribution back to you. The contributions are made with after-tax dollars, so no tax applies to money earned within the accounts. (The contribution limit is indexed annually to inflation, rounded to the nearest $500.)

When you withdraw money there is no penalty and the amount you take out is added to future contribution room. So, if you withdraw $35,000 for a major purchase, you can re-contribute that amount later without compromising the $5,000 contribution cap.

Unused contribution room may be carried forward without limit and, as there are no age or income restrictions you can contribute or make withdrawals for as long as you live. And, unlike a registered savings plan, you don't have to make mandatory withdrawals once you turn 71. That feature would give you additional tax-sheltered savings as you grow older. Contributions beyond the limit will be taxed at one per cent a month.

While the initial yields will be small -- about $150 in interest and a $60 savings in taxes at a 40 per cent marginal rate -- they will increase considerably over time.

Withdrawals will not have to be reported as income, so they won't affect Guaranteed Income Supplement (GIS) or Old Age Security (OAS) payments, and they won't reduce the age credit or affect eligibility for the child tax benefit. Basically, TFSAs won't reduce eligibility for any federal income-tested benefits.

Generally, the types of investments that will be permitted in a TFSA are the same as those permitted in a Registered Retirement Savings Plan (RRSP) such as mutual funds, securities listed on a designated stock exchange, guaranteed investment certificates (GICs), bonds, and certain shares of small business corporations (See right hand box for a comparison of RRSPs and TFSAs.)

You can also make "in kind" contributions to your TFSA, as long as the property is a qualified investment. You will be considered to have disposed of the property at its fair market value (FMV) at the time of the contribution. If the FMV is more than the cost of the property, you will have to report a capital gain on your income tax return. However, if the cost is more than the FMV, you may not claim the capital loss on your return. The amount of the contribution will be equal to the FMV of the property.

There are three basic types of TFSAs:

1. Savings: Generally these would hold cash or GICs.

2. Mutual Fund: These accounts will maintain long-term investments in the same way as any mutual fund.

3. Self-directed: As with any other self-directed investment plan, these accounts will offer the most flexibility in terms of your investment choices.

You may want to comparison shop as some institutions may charge commissions as well as administration and withdrawal fees for some types of TFSAs.

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