WRITER: SIMON GIANNAKIS

Disclaimer & Disclosure: Please review our policy as outlined on our website www.thatstockguy.NET .

Intended Audience
Individuals looking for different saving options with the goal of sheltering tax on earned investment income.

Summary Points to Take Away
(1) Benefits of a TFSA: (a) Income Splitting Opportunities (b) Tax Free Income and Withdrawals (c) Flexibility of Investment Options (d) Indefinite Carry-Forward of Contribution Room (e) No Income Requirement for Eligibility.

(2) TFSAs are different than Registered Retirement Savings Plan (RRSPs) in the following ways: (a) Contribution room for RRSPs is a function of the individual's earned income; as compared to TFSAs which are the same amongst all Canadians (b) Withdrawals from an RRSP are fully taxable, unlike those from a TFSA which aren't. (c) Contributions to an RRSP are deductable from taxable income in the year of the contribution, while for TFSA contributions are not tax deductable.

What is a Tax Free Savings Account (TFSA)?

Overview
A Tax Free Savings Account (TFSA) is a savings tool new to Canadians starting 2009. All investment income generated in the account is not subjected to tax. The contribution limit for 2009 is $5,000, which can be carried forward indefinitely.

Eligibility
Any Canadian resident age 18 or older with a Social Insurance Number can open a TFSA.

Why Take Advantage of a TFSA?

Income Splitting Opportunities
TFSA allows for income splitting opportunities between higher and lower income spouses given that attribution rules do not apply for income earned within the account. When considering the eligibility rules stated earlier (that the contribution room is not based on earned income) in theory a stay at home spouse could have the income earner of the family contribute toward both their TFSA and towards that of the stay at home spouse, with the end result being a lower family tax bill. This is an effective tax splitting strategy as long as each spouse has a different marginal tax rate (which is the case for most families) as it involves taking more taxable investment income out of the higher income spouse's hands.

Tax Free Income and Withdrawals
Earnings from investments in a TFSA, whether it is interest, dividends or capital gains are never subject to Canadian tax. Taxes aren't paid even upon withdraw from the account. This is unlike RRSP's, which only allows for the deferral of tax as the individual is ultimately taxed upon withdrawal. The TFSA doesn't defer tax on investment income; it eliminates it, which is one advantage it has over RRSPs.

Flexibility of Investment Options
Qualified investments for a TFSA include most financial products such as: Saving Accounts, GICs, Mutual Funds, Stocks, and Bonds or a mix of all or some of these various investment vehicles. Allowing for all these options makes a TFSA appropriate for almost everyone as these options cover off the majority of investment products that average individual sinks their savings into. In addition there is no foreign content restriction on the selection of investments such as pre 2005 RRSPs had.

Indefinite Carry forward of Contribution Room
TFSA contribution room is carry forwarded indefinitely; thus, individuals can contribute when cash becomes available. The available contribution room will be tracked by CRA and outlined on an individual's notice of assessment received after the filing of their personal tax return. Withdrawals from their TFSA are also added to the available unused contribution room starting the following year.

No Income Requirement for Eligibility
You don't need to have earned income to contribute to a TFSA. This is extremely beneficial for retirees and stay at home spouses. As well, there is no claw back on the TFSA contribution room for higher income individuals, anyone who meets eligibility requirements is entitled to the same contribution room (which for 2009 is $5k, indexed to inflation - increases in $500 increments) regardless if your earned income is $0 or $150k.

How it Compares to RRSPs

Where to go from here?
Remember the longer an individual's investments are in a TFSA, the faster they'll grow as the tax free income will compound at a higher rate. An RRSP is primarily intended for retirement. The TFSA is like an RRSP for everything else people save for (i.e. savings for short term purchases, supplemental long term income, tax shelter against investment income earned outside of an RRSP, etc). Put your highest taxable investments in your TFSA (i.e. if own shares of BCE and GICs outside of a TFSA, ensure you place the GIC's into the account first since it produces interest income which is 100% taxable as appose to investment gains from BCE, which would be made up of dividends and capital gains, which are both taxed at a lower level than interest income).