TFSA – Tax-Free Savings Account Announced in 2008 Canadian Budget

Starting in 2009, Canadian residents who are over 18 years of age will be eligible to contribute $5,000 per year to a TFSA (Tax Free Savings Account). Unused contribution room will be carried forward. Any investments inside this account (which is registered) will be tax-exempt and allowed to grow on a tax free basis.

In fact, to understand this account, think of it as like an RRSP except your contributions are not deductible. Conversely, the withdrawals are completely free of tax as well. The other major difference is that when you do make a withdrawal – you are credited with an equal amount of new contribution room being generated!

Other notes:

Income earned inside the account and withdrawals from the account WILL NOT affect eligibility for federal income-tested benefits and credits (this is a good thing)

You can contribute to a spouse or common-law partner’s TFSA

Assets in the plan are transferrable to the TFSA of a spouse or common-law partner upon death.

You can hold any investment in your TFSA that you can hold in your RRSP

The $5,000 contribution limit will be indexed to increase with inflation in $500 increments

More to come on the budget and strategies for the TFSA (don’t know if I’ll come up with 41 this time….)

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Preet Banerjee
Preet Banerjee
...is an independent consultant to the financial services industry and a personal finance commentator. You can learn more about Preet at his personal website and you can click here to follow him on Twitter.
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Showing 18 comments
  • Traciatim

    Hi Preet, I haven’t done much reading on this, but if you can contribute to a spousal TFSA, do you happen to know if there are any withdrawal rules regarding that contribution (like the 3 year RRSP rule) or could we use this as a poor mans investment loan.

    For example, Spouse 1 deposits 5000 in to the Spouse 2 TFSA. Spouse 2 makes a withdrawal, and now spouse 2 invests outside the TFSA for dividends and capital gains. Wash, rinse, repeat until spouse 2 has enough income to just fall under the tax threshold and then leave the last 5 grand in the TFSA for tax free gains, and each year keep that topped up so their ‘outside’ funds keep their income always just under the tax line.

  • Preet

    Hi Traciatim,

    There are no withdrawal attribution rules like the 3 year RRSP rule you are referring to since there was no deduction for funds on the way in – but I see where you are going.

    I think I see what you are getting at with respect to the attribution rules with respect to loaning funds/investments to a lower income spouse whereby income and capital gains earned from investments loaned can be attributed back to the transferor spouse. (Let me know if I understood you correctly)

    If so, what you are proposing is a way to wash the trail so that income and capital gains would not get attributed back to the higher tax bracket contributing spouse if I’m reading your question right. (with less tax efficient investments in the TFSA until maxed and the more tax efficient investments held outside when the room is used up, correct?)

    That is an excellent question and from what I have read, that has not been explicitly addressed. From the current rules, investment income attribution does not occur inside the account and since withdrawals are allowed on a tax-free basis and there are no contribution attribution rules it would seem that your strategy is valid. I’ll have to make some calls tomorrow to get clarity, hopefully if the loophole exists, it won’t get closed! Fingers crossed – and nice find!

  • Xenko

    So, if I understand this right, a TFSA is basically like a reversed RRSP?

    RRSP – Deposits not taxed, withdrawals taxed
    TFSA – Deposits are taxed (since it is after tax income), withdrawals not taxed

    It would be interesting to do see which is more tax efficient over a long time frame (25 years?). Would prepaying the tax in a TFSA deposit make up for the taxes you would pay on RRSP withdrawals, especially since an RRSP would tax both the initial deposit and any realized gains upon withdrawal.

    This would depend significantly on how much you withdraw per year and the tax bracket you are in at the time you make the deposit as well as the withdrawal.

    I can see the TFSA (as opposed to an RRSP) being very beneficial for me personally as a student since my tax rate is very low after deductions, giving me effectively tax free deposits and growth until I retire!

  • Traciatim

    Preet, yes you are bang on with your assumption. This looks like a really easy way to get money in the hands of a spouse so that you can split your investment income and be even more tax efficient as if they stay home they have no income.

  • Preet

    Hi Xenko,

    Technically the deposits are not taxed, but rather deposits are made from after-tax dollars.

    Also, assuming you are in the same tax bracket throughout your life, there would be no difference at the end of the day between saving to an RRSP and TFSA – but that is making some blanket assumptions and taking into account that you would have more invested upfront if you used the RRSP refund – there is a specific example on the Government website which you can see here. With just a little bit of planning you will find that the TFSA is indeed a great, great step in the right direction for taxpayers. :)

  • Preet

    Traciatim: I got off the phone with the Government. There are no rules that specifically address your question, but they will be introduced during either the 1st, 2nd or 3rd reading of the proposal, or during the submission to a committee of experts. Once it received royal acension, my guess is that the loophole will be closed.

    Also, they do not have a proposal to address the transfer in-kind of property (only cash at this time) and my guess it will be treated the same as an in-kind transfer from non-reg to RRSP (i.e. deemed disposition).

  • Traciatim

    Well, Let’s just hope their panel of experts leaves the loophole open for a year or two. I wouldn’t think they would leave a hole that huge but I sure didn’t see anything in the budget document, and when I read through that the attribution rules didn’t apply to spousal contributions I got excited that maybe I could transfer a bunch of funds to my spouse over the next few years while she starts a business.

    We’ll have to see how it all plays out, but at least I can get 5K in to her account at the bare minimum. Looks like I have a pile of saving to do through 2008 and 2009.

  • Xenko

    "Technically the deposits are not taxed, but rather deposits are made from after-tax dollars."

    That’s what I meant. RRSP contributions are pre-tax (so untaxed), while TFSA contributions are post-tax (so basically taxed).

    In the link you gave, it says this:

    "Any amounts withdrawn from an individual’s TFSA in a year will be added to the individual’s contribution room for the following year. This will give individuals who access their TFSA savings the ability to re-contribute an equivalent amount in the future."

    Does this include interest withdrawals? I open a TFSA on January 1st, 2009 and deposit $5,000. During the year, I make 5% interest, so on December 31st I now have $5,250 and I withdraw it. Does that mean I now have $5,250 of contribution room in the future, or just the $5,000 initial deposit?

  • Preet

    Hi Xenko, you are correct.

    When you make a withdrawal, the contribution room will be credited for the following tax year from what I understand (and that makes sense from an administrative point of view too). If you put in $5,000 in 2009 and your investment grows to $10,000 you can withdraw the $10,000 with no tax. The following year, you will have normally generated another $5,000 in contribution room, plus you will receive contribution room to offset your withdrawal of $10,000. That means the next year you will be able to contribute $15,000 instead of $5,000.

  • sundae1888

    @Traciatim: if you are the high income spouse, why do you need to "wash" the trail by contributing into TFSA and withdraw? Can’t you just "gift" the money to the spouse for investment?

  • Mackel

    Can the TFSA be used to shelter gains on day or short term stock trades? Can an individual make daily trades from within the TFSA sheltering the potential gains?

  • Preet

    @ Mackel – you are correct on both counts. Have fun!

  • Mackel

    So their are no restrictions on the length of time a stock or mutual must be held? Therefore the only restriction would be the length of time it takes to sell a stock, it being in the TFSA would not slow the process down?

  • Preet

    @ Mackel – again you are correct. The tax-free savings account is truly tax-free. It is a registered account, and anything that happens in there is sheltered from taxes as long as you remain within your contribution limits. The value of the account growing rapidly will not affect your contributions or attract any penalties, I’m just referring to the fact that if your NOA indicates you can contribute $5,000 for the year, you can only put in $5,000. But if you can grow that $5,000 to a million – nothing to worry about (at all!)

  • Carl J

    Hi Preet,

    Probably a stupid question (since my knowledge with RRSP, Investing, stocks, mutual funds and all that fun stuff is a bit lacking), but can you put TD’s e-Series into a TFSA?

    And also, is it possible to have multiple TFSAs (which total the $5000 a year)? So say I want to open a TFSA with my bank, but also one with an online broker such as QuestTrade or ShareOwner (I believe that the both will be offerering TFSAs).

    Thanks,
    Carl J

  • Preet

    @ Carl J – I’m just guessing about TD’s e-Series, but my guess is that it should be no problem as long as you have set it up properly. I do know the answer to the second question: You could have 5,000 TFSA accounts with $1 of contributions to each if you wanted.

  • Gordel

    So – trying to understand this – if I contribute 5000$ to my TFSA and I increase it to $500,000 or however much more (exact same way as with a “trading” account.. then I withdrawl 100,000 and pay no taxes on the 100,000? or whatever amount I withdrawl? What about capital gains?

  • Preet

    @ Gordel – correct. No capital gains on the way out (or while inside). Happy gambling! :)