The new Tax-Free Savings Account (TFSA)

In addition to saving for retirement, Canadians need to save for many different purposes over their lifetimes. A new Tax-Free Savings Account (TFSA) can be used to purchase a new car, renovate a house, start a small business or take a family vacation.

Regardless of your income level or age, you can benefit by saving money in eligible investment vehicles. Moreover you can watch those savings grow tax-free throughout your lifetime. It is your single most important personal savings vehicle since the introduction of the Registered Retirement Savings Plan (RRSP).

How the TFSA works

• Starting in 2009, Canadians aged 18 and older can save up to $5,000 every year in a TFSA.
• Contributions to a TFSA will not be deductible for income tax purposes but investment income, including capital gains, earned in a TFSA will not be taxed, even when withdrawn.
• Unused TFSA contribution room can be carried forward to future years.
• You can withdraw funds from the TFSA at any time for any purpose.
• The amount withdrawn can be put back in the TFSA at a later date without reducing your contribution room.
• Neither income earned in a TFSA nor withdrawals will affect your eligibility for federal income-tested benefits and credits such as the Guaranteed Income Supplement and the Canada Child Tax Benefit.
• Contributions to a spouse's TFSA will be allowed and TFSA assets can be transferred to a spouse upon death.

TFSA and RRSP plan similarities and differences

RRSP Contributions: Contributions to an RRSP are deductible and reduce your income for tax purposes.
• Key Difference: TFSA savings will not be deductible for income tax purposes.

Carry forward of contributions: Unused RRSP contributions can be carried forward.
• Similarity: Unused TFSA contributions can be carried forward to future years.

RRSP Withdrawals: Withdrawals from an RRSP are added to your income and taxed at current rates.
• Key Difference: Your TFSA withdrawals will be tax-free.

RRSP investment growth: Investment growth within an RRSP is not taxed—it is tax-free.
• Similarity: Your TFSA investment growth within your account will be tax-free.

An RRSP is primarily intended for retirement. Though a TFSA is like an RRSP, it is intended for everything else in your life.

Tax advantaged flexibility for life

If you need to access monies from savings, cash from your RRSP would become immediately taxable. The TFSA withdrawals are not subject to tax. Thus you have a perfect investment vehicle where capital gains and other investment income earned in a TFSA will not be taxed while invested, nor when withdrawn when needed. Unlike RRSPs, you can re-contribute withdrawal amounts at any time.

The TFSA offers a difference, for example:

• John withdraws $20,000 tax-free from his TFSA to renovate his home. John will be able to re-contribute the $20,000 to his TFSA in the future without affecting his other available contribution room. Had he used his RRSP savings, he would have needed to withdraw up to $37,000 to pay taxes and cover the cost of the renovation, and this contribution room would have been lost.

Benefits of saving in a TFSA

Because capital gains and other investment income earned in a TFSA will not be taxed, a person contributing $400 a month to a TFSA for 20 years will enjoy additional savings of $22,090 compared to saving in anunregistered account.

Source: CRA

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