You can’t please everyone, but when it comes to tax measures, it’s hard to please anyone. The one exception came in the form of the new tax-free savings account (TFSA) introduced by the federal government in its recent budget.
Although those hoping for relief to the capital gains tax were disappointed, the business press, financial advisers and mutual fund managers were generally pleased with this new measure.
Unlike most new tax programs that are burdened with plenty of restrictions, this one is almost a model of simplicity. This is how it works:
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If you are 18 or older, have a social insurance number and are a resident of Canada, you qualify. It’s as simple as that.
Beginning in 2009, you can contribute up to $5,000 a year to your registered TFSA. You don’t even have to earn a certain level or type of income to make your contribution, unlike the requirements for contributions to a Registered Retirement Saving Plan. Another key difference between the savings account and an RRSP is that your deposit is not deductible, so you are making your contribution with after-tax dollars. That is why when it comes time to make a withdrawal, the money, including the income earned in the account, is not taxable.
Any unused contribution room can be carried forward indefinitely and you can dip into your savings account at any time. Doing so also creates future contribution room. But you will be penalized if you contribute more than the annual $5,000 limit. Interest on money borrowed to invest in a TFSA is not deductible.
You can also contribute up to $5,000 per year to a TFSA for your spouse or common-law partner without attribution, effectively allowing both of you to collectively shelter up to $10,000 of new investment per year. The government has also indexed the $5,000 amount to inflation in $500 increments.
Almost any of the investments permitted for an RRSP account, such as mutual funds, stocks, bonds and guaranteed investment certificates, also qualify for a TFSA. Any capital gains in the account can be withdrawn tax-free, but you will not be able to claim the capital loss against your income.
The TFSA may be transferred tax-free to a spouse or common-law partner on death, or to a former spouse on marital breakdown, and the funds may be withdrawn by that spouse at any time tax-free.
Does the flexibility of this program make contributing to your RRSP less appealing?
Not really, because the plans appear to be more complementary than competitive in nature.
While the taxation of withdrawals from your RRSP will probably ensure that you don’t touch those funds until absolutely necessary, a TSFA can provide a flexible alternative source of tax-free cash flow to meet special needs.
Larry Roche is a tax analyst with farm taxation and planning specialists Farm Business Consultants Inc. He can be contacted at fbc@fbc.ca or call 800-860-7011.
