Tuesday, February 26, 2008

Tax-Free Savings Account—A Savings Plan for All Canadians

From the Federal Budget

Savings provide a means by which Canadians can invest in the future and improve their standard of living. For individual Canadians and their families, the accumulation of personal savings brings the security and peace of mind that come with the knowledge that funds will be available in the event of an emergency or for individuals to achieve their goals, such as starting a small business, purchasing a new home or a new car, or taking a vacation. In these ways, savings contribute to a higher standard of living for Canadians.

In support of the economic agenda set out in Advantage Canada, and to improve incentives for Canadians to save, the Government proposes to reduce the taxation of savings through the introduction of a Tax-Free Savings Account (TFSA)—a flexible, registered general-purpose account that will allow Canadians to earn tax-free investment income.

How the Tax-Free Savings Account Will Work

  • Starting in 2009, Canadian residents age 18 or older will be eligible to contribute up to $5,000 annually to a TFSA, with unused room being carried forward.
  • Contributions will not be deductible.
  • Capital gains and other investment income earned in a TFSA will not be taxed.
  • Withdrawals will be tax-free.
  • Neither income earned within a TFSA nor withdrawals from it will affect eligibility for federal income-tested benefits and credits.
  • Withdrawals will create contribution room for future savings.
  • Contributions to a spouse’s or common-law partner’s TFSA will be allowed, and TFSA assets will be transferable to the TFSA of a spouse or common-law partner upon death.
  • Qualified investments include all arm’s-length Registered Retirement Savings Plan (RRSP) qualified investments.
  • The $5,000 annual contribution limit will be indexed to inflation in $500 increments.

The TFSA will provide a flexible savings vehicle for Canadians. Since not everyone is able to save each year, individuals who are unable to contribute $5,000 in a year will be able to carry forward unused contribution room to future years. In addition, in recognition of the fact that most people are likely to have multiple savings objectives at the various stages of their lives—e.g. to purchase a car, home or cottage—the full amount of withdrawals may be re-contributed to a TFSA in the future, to ensure that there is no loss in a person’s total savings room. In recognition of the fact that couples often make their savings decisions and plan for their financial security on a joint basis, individuals may contribute to the TFSA of their spouse or common-law partner, subject to the spouse or partner’s available contribution room.

Canadians will also benefit by being able to use the TFSA to start saving early for a range of needs they may have in the future. Many Canadians may prefer to use a TFSA to save for pre-retirement needs given the absence of tax consequences on withdrawals and the ability to avoid the use of RRSP room for non-retirement savings needs.

The TFSA will also provide seniors with a savings vehicle to meet any ongoing savings needs, something to which they have only limited access once they are over the age of 71 and are required to begin drawing down their retirement savings. Based on current savings patterns, seniors are expected to receive one-half of the total benefits provided by the TFSA.

This is a fantastic new measure for many Canadians. It will benefit low income Canadians the most who may not realize a large benefit from RRSP tax deductions or who have government benefits clawed back because of their income level. It is also my hope that it will encourage investing and saving more than the current lacklustre level.


pricedoutfornow said...

Sooo...I can put in $5000 worth of shares and if these shares subsequently go up to a market value of $20,000 (ok I'm dreaming) and I sell, then my capital gains will be tax free?
Sweet! Sounds good to me.
Though if you have that $5000 sitting in a savings account/GIC earning 4% a year, you won't pay tax on that $200 of interest income.
Not so sweet. Better than nothing though and maybe it will encourage people to save rather than spend.

jesse said...

Details can be found here

Jason R. said...

I guess the question now is when does the benefit of tax free appreciation and withdrawals from a TFSA start outweighing the benefit derived from tax deductions received by contributing to an RRSP.

jesse said...

pricedoutfornow and jason r.: follow my link above and look for the table "Net Proceeds From Saving in a TFSA Relative to Other Savings Vehicles" to see a comparison to RRSPs.

The proposed TFSA comes from after-tax income instead so the end result is similar to the returns from RRSPs. The TFSA has advantages that it can be accessed anytime for any reason.

Robert Reynolds - HMR Insurance said...

Something I have always wondered about in regards to RRSP versus non-registered investments.

The general rule of thumb is that you max out your RRSP and then set up a non-reg RSP.

With an RRSP you save the tax NOW but have to pay it later at retirement. Your investments also loose their "identity" capital gains and dividends in an RRSP are treated as interest and fully taxed.

Given that at the moment I am in a low-ish 25% tax bracket and my hopes and aspirations are that one day I will be rich and famous and in a top tax bracket (42%-ish) is it better to invest in an RRSP, save the 25% tax now and have added growth, but higher tax when I take it out and loss of investment identity.
Keep everything non-reg pay the 25% tax now, have slower growth but better taxation on dividends and capital gains and not have to pay a (hopefully) higher tax rate when I retire?

Radley77 said...


I am quite excited regarding the TSFA as well!

I recently did a post on my blog that highlights the divergence between nominal house prices and nominal GDP per capita.

I was wondering if you would be interested in interpreting a similar sort of analysis with Vancouver house prices?

I think this helps distinguish the fundamental relationship between economic activity and house prices and incorporates additional economic activity due to things like the Olympics, or in our case additional capital expenditures related to oil and gas.

I think the Olympics and oil sands have developed storyline plots that are meant to substantiate the
economics of house prices, wheras actual economic activity in terms of GDP per capita has not increased to nearly the same extent.

Panda said...

The tax on income from $5k is not all that much, although I can see that it should add up after a lifetime of contributions. Ultimately the most profitable angle might be to buy shares in financial-type companies that will benefit from this program.

patriotz said...

This is of practical benefit only for those people who have maxed out their RRSP's and have taxable non-registered investments. The tax advantages are essentially the same as for RRSP's except they are applied at the after-tax rather than before-tax side.

Which includes me, so I'm not complaining. But this does not really benefit the ordinary person, who has unused RRSP contribution room (not to mention non-deductible mortgage or consumer debt), at all.

Since nobody else pointed it out, your interest-bearing investments should go into such an account first, since dividends and capital gains already get preferential tax treatment, and you can't apply capital losses from a TFSA against taxable gains. Just like for RRSP's.

patriotz said...

I should have added, this may well get some people to put their free cash in such an account when they would be way better off paying their credit card balances, or most likely better off paying down their mortgages. This is a tax-free savings vehicle which is already available to the people who really need it and gets better returns.

The law of unintended consequences.

condohype said...

I am very excited about the TFSA. It's a good program and it does a lot more good for lower- and middle-income Canadians than a cut on capital gains taxes would do. The fact that all withdrawals can be replaced dollar for dollar is huge. If you happen to hold a few stocks that surge in value within the TFSA, you can cash out and be left with a huge shelter space for future investments because the entire withdrawal amount is added to your contribution room.