Tax-Free Savings Account

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The Tax-Free Savings Account (TFSA) is an account that provides tax benefits for saving. Contributions to a TFSA are not deductible for income tax purposes. Investment income, including capital gains and dividends, earned in a TFSA is not taxed, even when withdrawn. It was introduced by Jim Flaherty, Canadian federal Minister of Finance, in the 2008 federal budget. It was a significant measure in the budget and came into effect on January 1, 2009. This measure was supported by the C.D. Howe Institute, which stated; “This tax policy gem is very good news for Canadians, and Mr. Flaherty and his government deserve credit for a novel program”.

TFSA Benefits

The TFSA is an investment option for Canadian residents 18 years and older wanting to save for the future. The TFSA’s flexible structure allows the holder to be able to withdraw money from the account at any time, free of taxes. The allocations into the account are non-deductible; however this represents a lucrative opportunity for individuals with left-over income to invest in a savings vehicle, without the pressure of time constraints. The account also alleviates the burden of the capital gains tax. The interest-income will be able to compound tax-free. In essence, the account-holder can withdraw any amount out of the account, free from capital gains and/or withdrawal taxes.

One mechanism in the design of the TFSA is the carry-over aspect. Any unused space under the $5,000 cap can be carried forward to subsequent years, without any upward limit. The TFSA also allows income splitting to an extent, because a higher-earning spouse can contribute to the TFSA of a lower-earning spouse.

The $5,000 annual contribution limit will be indexed to the Consumer Price Index (CPI), in $500 increments, in order to account for inflation.

TFSA Contribution Room

People are entitled to make contributions up to these amounts for each year they are aged 18 and older:

  • 2009: $5,000
  • 2010: $5,000
  • 2011: $5,000
  • 2012: $5,000
  • 2013: $5,500

Over-contributions to TFSA

On June 1, 2010, the Canada Revenue Agency (CRA) mailed about 72,000 overcontribution letters to TFSA holders, representing about 1.5% of all 4.7 million TFSA-holders. The letters and calculations were based on information CRA received from financial institutions.

As a result of this mailing, financial institutions received many calls from confused clients. The TFSA holders did not realize that withdrawals from the TFSA increase the available contribution room not in the current calendar year, but the next calendar year. For example, if you contributed $5,000 to a TFSA in January 2009, withdrew it all in July, and then later re-contributed the $5,000 in November 2009, this would put you in an over-contribution position because the $5,000 July withdrawal does not create further room until 2010. This rule has caused much confusion.

The CRA recommended taxpayers still send in their payment penalty with the TFSA return and a letter explaining the situation by June 30, 2010. The CRA stated it would review this information on a case by case basis. If relief was granted, the CRA said they would return the payment. As of June 2010, the CRA has received about 10,000 responses to its letter from taxpayers. TFSA holders can wait until they receive a Notice of Assessment, expected to be issued in August 2010, and then either file a formal Notice of Objection or apply for administrative relief by writing to the CRA. The risk of waiting, however, is that a late-filing penalty as well as interest may be charged by the CRA.

TFSA Eligible Investments

A TFSA can hold any investments that are RRSP eligible, including: publicly traded shares on eligible exchanges, eligible shares of private corporations, certain debt obligations, installment receipts, money denominated in any currency, trust interests including mutual funds and real estate investment trusts, annuity contracts, warrants, rights and options, registered investments, royalty units, partnership units, and depository receipts.

Difference between TFSA and RRSP

The Canada Revenue Agency (CRA) describes the difference between a TFSA and an RRSP as follows: “An RRSP is primarily intended for retirement. The TFSA is like an RRSP for everything else in your life.”

In a sense the tax treatment of a TFSA is the opposite of a Registered Retirement Savings Plan (RRSP). For RRSPs, there is a tax deduction for contributions to a RRSP, and withdrawals of contributions and investment income are all taxable. In contrast, there is no tax deduction for contributions to TFSA, and there is no tax on withdrawals of investment income or contributions from the account. Beginning in 2013, contribution room in the TFSA has increased to $5,500 per calendar year, with a limit of $5,000 per year for each year before 2013. This money can then be withdrawn at any point of time, without penalty. Unlike RRSP’s, which must be withdrawn before the holder turns 71, the TFSA does not expire. The contribution room for funds withdrawn from a TFSA is reallocated in the tax year after the withdrawal, unlike an RRSP, where the contribution room is permanently reduced once a contribution is made.

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