Tories introduce Tax-Free Savings Account
Philip Stavrou, CTV.ca News
Published Tuesday, February 26, 2008 4:58PM EST
Last Updated Friday, May 18, 2012 7:45PM EDT
OTTAWA - Canadians are being encouraged to save for life's big events, not just retirement, with the introduction of the Tax-Free Savings Account (TFSA) in the 2008 Budget.
Starting in 2009, Canadians aged 18 and older can contribute up to $5,000 annually (from their taxable income) to a TFSA.
The investment income, including capital gains, earned in a TFSA will not be taxed -- even when withdrawn.
The plan also allows an investor to withdraw funds from the TFSA at any time and for any purpose.
The withdrawal amount can then be put back at a later date without reducing contribution room.
Additionally, if an investor puts less than $5,000 into a TFSA in a given year, the unused room can be carried forward to future years.
"It's the first account of its kind in Canadian history," Finance Minister Jim Flaherty said in his 2008 Budget Speech.
Don Scott, a tax partner at Welch LLP, told CTV.ca that the TFSA will benefit lower and middle-income taxpayers that are looking for a way to save money.
"You can use the plan to save for a special purpose -- a down payment on a house or to buy a car," said Scott. "It provides an incentive to put money away for that purpose (and) you get the tax break of not having to pay tax on the income that's earned on it while you're saving."
As an example, an individual contributing $200 a month to a TFSA for 20 years, at a 5.5 per cent rate of return, will earn about $11,045 more in savings than if the investment had been made in a taxable savings vehicle (unregistered account).
Seniors will also benefit because they will be able save funds once their age restricts them from contributing to an RRSP, said Scott.
Income or capital gains earned in a TFSA will also not affect eligibility for federal income-tested benefits such as the Guaranteed Income Supplement for low income seniors. The same applies to withdrawals from a TFSA account.
For example, a modest or low-income retired couple, earning $2,000 a year in interest income on an unregistered basis, would see their GIS benefits reduced by $1,000.
If the interest was being earned in a TFSA account, there would be no reduction to their GIS.
Based on current savings patterns, seniors are expected to receive one-half of the total benefits provided by the TFSA, says the 2008 Budget.
The budget estimates that the introduction of TFSAs will reduce federal revenues by $5 million in 2008-09 and $50 million in 2009-10. By 2012-13, the estimated tax savings from TFSAs will be $385 million.
Over the next 20 years, the annual tax savings is estimated to grow to over $3 billion annually.
However, the new account may draw people away from contributing to an RRSP, said Scott.
"It might for the lower and middle-income earner that's wanted to save some money... with the concern that when they took the money out they might pay more tax then the savings they got when they put it in."
Overall, because of the nature of the new plan there will most likely be a better encouragement to put savings away instead of spending it.
"Will savings reduce? Probably not," said Scott. "It's now just a question of which type of plan are you putting your money into."
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.
(Source: 2008 Budget)