Recently, the federal government released details regarding the 2008-09 Federal Budget. The highlight to this year’s budget has to be the Tax-Free Savings Account.
Beginning in 2009, people age 18 and older will acquire $5,000 of TFSA contribution room each year. The annual limit will be indexed to inflation and the annual additions to contribution room will be rounded to the nearest $500. Unused contribution room will be carried forward to future years. As an example, if you do not contribute to a TFSA in 2009 then your contribution room will be $10,000 in 2010.
Individuals who contribute to a TFSA are able to make tax-free withdrawals. The unused contribution room is increased when withdrawals are made. The fact that withdrawals from a TFSA are tax-free and your contribution room will be replenished creates a higher level of flexibility than RRSP accounts.
Often we see individuals who make RRSP mistakes. The most common of which is making a contribution in a lower income year and then withdrawing the funds a few years later when income levels are higher. Younger individuals in a lower tax bracket should first consider the TFSA, which offers the flexibility to withdraw funds.
The exciting news about the TFSA is that all income generated within the account is exempt from tax. This includes interest, dividends and capital gains. This type of an account may be ideal for individuals who want to hold investments such as GICs, term deposits, or high interest savings accounts. The TFSA will also be eligible to hold the same types of qualifying investments that an RRSP may hold, including publicly traded securities, bonds, and mutual funds.
The TFSA provides an income splitting benefit for married couples (and common-law). The higher income spouse may contribute to the other spouse’s TFSA. This is one of the exceptions to the “attribution rules” that couples should take advantage of. Married couples (and common-law) may have the benefit of rolling-over the TFSA to the surviving spouse if one of them were to pass away. This new tax-sheltered vehicle should support savings as a household.
Contributions into a TFSA do not result in a tax deduction. Medium and high income earners with likely use both an RRSP and TFSA. Individuals who are in a higher income
tax bracket will still be attracted to RRSPs, which offer the upfront tax deduction. Higher income people who are making their maximum annual RRSP contributions may also have a TFSA as a means to shelter more savings from tax.
Individuals who have savings outside of a registered plan should take full advantage of the TFSA when it is available in 2009. This account may be used for planned activities, such as a home purchase, travels, or a new vehicle. Keeping funds in this type of an account may be ideal to fund emergency costs, such as unexpected medical bills or periods of unemployment.
The TFSA should benefit everyone who has savings or would like to begin saving. Younger people will be able to accumulate funds faster if they are not taxed annually on their investment income. Older individuals who have GICs or term deposits may be able to reduce some of their taxable income by shifting funds that are currently in a taxable account to the TFSA. A reduction in income may allow older individuals to receive more benefits from income tested credits and supplements.
The TFSA will only benefit those who save and take advantage of it. We encourage individuals to meet with their accountant and financial advisor to adjust their long-term financial plan to include the new TFSA for 2009.