Tax-free Savings Accounts Are Coming
David Christianson, CFP, R.F.P., TEP
By now, I’m sure you’ve heard of the new Tax Free Savings Account, or TFSA. These are going to be a big deal, with most investors interested and intending to set one up. They can be opened starting in January, 2009.
That’s right; in spite of all the advertising and articles you are reading about the TFSA, you cannot put money into one now. I have received a number of e-mails and phone calls from people who think they’ve been left out, so I thought this clarification is timely.
However, a number of financial institutions are encouraging you to open them now, so you are ready to make a deposit with them early in the New Year.
(N.B. Though contributions cannot begin until January 2nd, Wellington West Capital Inc. Investment Advisors now have the opportunity to open TFSA accounts for their clients in advance of the official Federal launch date.)
The TFSA will allow all Canadian resident taxpayers over the age of 18 (possibly older in provinces where the age of majority is older) to put up to $5,000 per year into a separate investment account that will be exempt from income taxes on its investment earnings. The annual limit will go up with inflation, in minimum $500 increments.
The TFSA is quite different from an RRSP in a number of ways. There is no tax deduction for putting the money in. There is no tax liability when you withdraw the money. Any withdrawal can be replaced by an additional deposit in the following tax year. In other words, you do not lose any TFSA contribution room by making a withdrawal.
For example, if you deposit $5,000 to your new TFSA in January, then withdraw $2,000 for a vacation in March, you can deposit $2,000 back into your TFSA as early as January of the following year. By then, your limit will have increased to $7,000, since you get a fresh $5,000 limit for a new tax year.
Unused contribution room carries forward indefinitely.
You can use any investment vehicle that you could use in an RRSP. You can contribute existing investments in-kind, but it will be considered a deemed disposition and any gain incurred will be taxable. On the other hand, any incurred loss on a transfer will be denied.
So, if you have a capital loss you want to claim, sell the security and contribute the cash to the TFSA. You will still have to wait 31 days before buying it back if you want to claim the capital loss.
You might consider the TFSA to be a complementary savings vehicle to your RRSP, or use it as an alternative and decrease your RRSP contribution. This means more tax now, but less tax on withdrawal and no negative impact on income-tested government benefits after retirement. These include the Age Credit and OAS clawback.
Conservative investors and advisors think that the TFSA is a great place to put interest-bearing investments (like bonds and GICs), sheltering this interest income which is normally subject to full taxation at that person’s highest marginal tax rate.
More aggressive investors think it’s a great place to put speculative investments that have the potential for significant capital gains. An example here might be a junior mining stock, where a home run could turn a $5,000 investment into $25,000.
Wouldn’t it be great to have that capital gain totally tax-free?
The fly in the ointment is that the capital loss you incur if it doesn’t work out cannot be applied against other capital gains. So this is only a strategy for someone who can afford to lose the $5,000.
For people who have no RRSP contribution room because they do not have “earned” income (from employment or self-employment), or have a large Pension Adjustment, the TFSA may be particularly useful. For anyone holding cash reserves outside of RRSPs, it would seem like an obvious vehicle to use.
Every once in a while the government gets it right.
* * *
This article originally appeared in the Winnipeg Free Press on Friday, November 6, 2008.
David Christianson is a fee-only financial planner and investment counsel with Wellington West Total Wealth Management Inc. His column, ‘Dollars & Sense’ appears Fridays in the Winnipeg Free Press.