Although the tax-free savings account is still less than a year old, it has already established itself as a useful component in the financial plans of many Canadians. The TFSA is also becoming an essential companion to the RRSP program.

“One complements the other,” says Lee Ann Davies, head of retirement strategies with Royal Bank of Canadain Toronto. She says financial advisors are taking the opportunity to discuss the TFSA when their clients come in to talk about making an RRSP contribution.

Whereas the RRSP is intended to help Canadians save for retirement, a TFSA has been designed to encourage medium- or long-term savings for any purpose. “The TFSA gives you another tool to plan your income level to meet your lifestyle needs,” says Jason Safar, partner in the tax services practice of PricewaterhouseCoopers LLP in Mississauga, Ont.

Introduced on Jan. 1, a TFSA allows a Canadian over the age of 18 to contribute up to $5,000 annually into a tax-sheltered account. The TFSA rules are mirror opposites to the those for RRSPs: while TFSA contributions are not tax-deductible, withdrawals are free from taxes. Unused TFSA contribution room is carried forward indefinitely, and any withdrawal in a given year is added to the contribution room of the following year.

If a taxpayer is unable to maximize both an RRSP and TFSA, and their income is higher today than it is expected to be in the future, it might make more sense to favour the RRSP and receive the tax credit. If an individual is in a lower tax bracket, then a TFSA contribution might make more sense.

Another strategy for individuals with limited resources is to make an RRSP contribution and then contribute the refund to a TFSA.

Generally, all investments that are RRSP-eligible are also eligible for a TFSA. It’s helpful to keep in mind that locked-in investments, such as a guaranteed investment certificate, will not permit the investor to take advantage of one of the TFSA’s key advantages — withdrawals without taxes that can be redeposited in future years.

In addition, TFSAs can be used as collateral for loans, which means there are a number of leveraging strategies available. If assets inside an RRSP are used as collateral, the entire value of the RRSP must be added to income for the year.

Retirees, and those approaching retirement, have been the quickest to take advantage of the introduction of the TFSA. According to an RBC poll released in October, of those adult Canadians who’ve heard of the TFSA and who are 55 years or older, 36% have opened a TFSA. That compares with 29% for the entire adult population who’ve heard of the TFSA.

Older Canadians may be more experienced with investing, and thus quicker to interpret and understand the many positive attributes of the TFSA, Davies suggests. TFSAs offer Canadians, particularly retirees and those who’ve converted their RRSPs into RRIFs, an opportunity to shelter more of their income. In addition, money that must be withdrawn from a RRIF can be used to contribute to a TFSA.

In the 2008 tax year, many Canadians found themselves selling investments held in their RRIFs at a loss in order to make their mandatory minimum withdrawals; but there are no mandated minimum yearly withdrawals from TFSAs, another positive feature for retirees.

Unlike RRSP or RRIF withdrawals, those from a TFSA do not affect income-tested benefits and credits such as the Canada Pension Plan or old-age security. Contributing to a TFSA rather than an RRSP during the working years might be particularly useful for low-income Canadians who don’t want to risk losing any of their income-tested benefits in retirement.

On death, a TFSA holder can name his or her spouse as a successor accountholder of the account. Upon the death of the original TFSA holder, the spouse takes over as the new owner of the account, which remains tax-exempt. If the surviving spouse already has a TFSA, the money in the deceased’s TFSA can be rolled into the surviving spouse’s TFSA without affecting contribution room.

All provinces and territories, except Quebec and Nunavut, permit a TFSA holder to name a beneficiary. Doing so prevents the TFSA from being included in the estate, thus avoiding probate costs.

But unless the TFSA passes to a surviving spouse, the plan loses its tax-exempt status. All income earned or gains made prior to the death of the holder are not taxable, but the gains made after the holder’s death are subject to taxes. IE