Canadians will now have a separate account for their savings, in which the funds that are contributed have already been taxed and any income earned in the fund, even when withdrawn, emerge from the account free of tax.

Starting in 2009, the Tax-Free Savings Account will give Canadian individuals (other than a trust) who are18 years or older $5,000 of TFSA contribution room each year. The $5,000 limit will be indexed to inflation, with additional contribution room rounded to the nearest $500. An individual will be allowed to hold more than one TFSA, although the eligible contribution limit remains the same.

“Everyone should have one of these,” says Jamie Golombek, vice president of taxation and estate planning for Toronto-based AIM Trimark. “This is a tax-free savings plan, there’s no down side.

“This is an incredibly flexible plan,” he adds, “that will allow people to save for a home, a car, a wedding, anything.”

In a TFSA, unused contribution room can be carried forward every year, without limit. Any amount withdrawn from a TFSA in a year is added to the individual’s contribution room for the following year. Excess contributions will be taxed 1% a month.

In effect, the TFSA is a mirror image of the Registered Retirement Savings Plan, except rather than funds going in tax deferred and then taxed at withdrawal, as with an RRSP, the funds contributed to a TFSA remain eligible to income tax going in and are free of tax when withdrawn. All investment income, losses and gains generated from investments held within a TFSA are exempt from tax and not taxed when withdrawn.

Will it be more advantageous for Canadians to contribute to the new TFSA or to their RRSPs? That will largely depend on your tax rate assumptions, Golombek says.

“If you’re in a high tax bracket now, and expect to be in a low bracket later, then you might choose to contribute to an RRSP,” he says. “But if you’re in a low tax bracket now and expect to be in a higher tax bracket later, you will want a TFSA.”

Any amount withdrawn from a TFSA won’t be eligible for income-tested benefits or credits, such as the Canada Child Tax Benefit or the Goods and Services Tax Credit, nor will any amount be taken into account in determining other benefits that are based on the individual’s income level, such as Old Age Security benefits or Employment Insurance benefits.

A TFSA will generally be allowed to hold the same investments as an RRSP, including mutual funds, stocks, bonds, GICs, and in certain cases, shares of small business corporations.

The TFSA appears to be the way the Conservatives intend to fulfill their election promise to eliminate capital gains taxes on money re-invested within a certain period of time.

“This won’t satisfy those who were looking for a elimination of capital gains reinvested within six months, as the Conservatives promised,” Golombek says. “But this goes a long way toward their general policy objective of allowing Canadians to rollover capital gains.”

However, the government is proposing that a TFSA be prohibited from holding investments in any entities with which the account holder does not deal at arm’s length—including for this purpose an entity of which the account holder is a “specified shareholder” as defined in the Income Tax Act or in which the account holder has an analogous interest (generally a 10% greater interest, together with non-arm’s length persons).

Interest on money borrowed to invest in a TFSA will not be tax deductible, but there will be no prohibition on an individual’s ability to use his or her TFSA assets as collateral for a loan.

An exception to the “attribution rules,” which govern the transferring of property from spouse to spouse, will allow individuals to take advantage of the TFSA contribution
room available to them. Whereas the income tax rules generally treat any income earned on transferred property as income of the individual who transferred it, income earned in a TFSA from funds transferred into a spouse’s TFSA is considered as belonging to the transferee spouse.

An individual’s TFSA will lose its tax-exempt status upon the individual’s death, with investment income and gains that accrue in the account after the individual’s death considered taxable, while those that accrued before death remaining exempt.

@page_break@However, an individual can name his or her spouse or common-law partner as successor account holder, and the account will keep its tax-exempt status. If the surviving spouse already has a TFSA, the assets of a deceased individual’s TFSA can be transferred to the spouse’s TFSA regardless of whether the survivor has available contribution room, and
without reducing the survivor’s existing room.

In the case of marriage breakdown or end of a common-law partnership, funds can be transferred directly from the TFSA of one spouse to the other. The transfer will not
re-instate contribution room for the transferor, and will not count against the contribution room of the transferee.

An individual who becomes non-resident will be allowed to maintain his or her TFSA and continue to benefit from the exemption from tax on investment income and withdrawals. However, non-residents will not be permitted to make new contributions, nor will the non-resident accrue additional contribution room for any year the individiual remains a non-resident.

The Canada Revenue Agency will determine TFSA contribution room for each eligible individual who files an annual income tax return. Individuals who have not filed returns for prior years will be allowed to establish their entitlement to contribution room by filing a return for those years or by other means

Financial institutions currently eligible to issue RRSPs, including Canadian trust companies, life insurers, banks and credit union, will be allowed to issue TFSAs. To provide the CRA with the means to determine contribution room and monitor compliance, TFSA issuers will be required to file annual information returns, which are expected to include, for example, the value of an account’s assets at the beginning and end of the year and the amount of contributions, withdrawals and transfers made during that year.