The Tax-Free Savings Account (TFSA) – A Creative Financial Approach
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The Canadian Government deposited their 2008 budget this February 26th. So at the same time that the Montreal Canadiens were showing their inability to be creative enough to bring Marian Hossa (!) in our team, the Canadian Government were including a nice innovation called the Tax-Free Savings Account (TFSA) in their 2008 budget. This measure will take effect as of |
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What is the TFSA?
The TFSA is an account where you can put money (up to $5,000 per year per person) and all gains (interest income, dividend and capital gains) are non taxable. Even better, you can withdraw the money from your account at any time under no restriction and without being taxed on the amount of the withdrawal.
At first, the RRSP and the TFSA could look alike. However, when you take a moment to analyse both of them, you will find several differences. I completed the following chart to help you out determining which account is best for your personal finance.
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RRSP |
TFSA |
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Minimum age to start contributing |
No minimum. The individual must declare income. |
Minimum age of 18. |
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Maximum amount of contribution |
$19,000 or 18% of declared income. The maximum amount is increasing year after year. |
$5,000 per year. |
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Contribution is tax deductible |
Yes. |
No. |
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Investment gains (interest, dividend and capital gains) are not taxable |
Yes. |
Yes. |
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Spousal contribution are permitted |
Yes. |
Yes. |
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Withdrawals from the account are taxable. |
Yes. They are not taxable in a case of a Home Buyer Plan and to go back to school (those 2 programs work under certain restrictions). |
No. Withdrawals from the TFSA are not taxable. |
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Unused contribution room can be carried forward. |
Yes. |
Yes. |
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You can “reimburse” your withdrawal in the account. |
No. You can only reimburse under the HBP and return to school program under certain restrictions. |
Yes. You can reimburse your withdrawals from the TFSA at any time without penalties. |
February 28th, 2008 at 8:27 am
Hey FB, thanks for the mention. It’s too bad that borrowed interest wont’ be tax deductible with this account, however, it’s still a great account regardless. So many possibilities!
February 28th, 2008 at 8:36 am
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February 28th, 2008 at 8:41 am
Thanks for the link FB. FT is right. The budget specifically mentions that borrowing to invest in the TFSA is not tax deductible.
February 28th, 2008 at 10:44 am
Is the smith manouvre really that profitable? Doesn’t it just convert your mortgage into an investment loan so you can tax-deduct the interest? Typically you can get a mortgage rate that is cheaper than the prevailing HELOC rates, so much of what you gain in a tax savings is lost to the higher rate. The timing of when you lock into your mortgage might make a difference.
I did the calculations on converting my own mortgage in the past, and the amount of the return was very small. In general though, borrowing to buy investments is way better than borrowing to buy consumption.
February 28th, 2008 at 8:20 pm
FT and CC;
That’s too bad for the SM! I guess I’ll have to wait and pray to have the tax exemption on the capital gain next year!!
CR;
I am a firm believer of leveraging based on the power of compounding interest. Many financial institution (including the National Bank starting this April) allow you to combine a fixed mortgage with a HELOC. On the other side, it has been mathematically proven that if you take the variable mortgage rate over 25 years, you will end up paying less interest than renewing a fixed rate every 5 years.
February 29th, 2008 at 9:49 pm
I was thinking about this again. Please correct me if I’m wrong, but I think it might actually be useful for the Smith Manouvre Investments. Not on the front end but on the back end.
It is difficult to say exactly until the TFSA comes into play but here is an idea, if transfers in kind are allowed. If we are able to do a “transfer in kind” of non-registered funds into a TFSA closer to retirement in order to avoid taxation and wash non-registered funds like those of the Smith Manouvre before we actually need it. Just say your a couple and want to retire in 10 years, so you together have 100,000 of TFSA room, you transfer in kind from the non-registered funds of the SM - then withdraw funds from the TFSA to avoid taxation and create room again to do it again the next year? That would mean that a couple who needed $100,000 before tax could now only need to save $70,0000 - since there would be no tax on the money from the TFSA.
I also mentioned this over at Canadian Dream- http://blog.canadian-dream-free-at-45.com/?p=364#comment-3800 but haven’t got a response yet. I’d appreciate some FPs opinions on this.
March 1st, 2008 at 5:50 pm
Quentin;
I guess it would work but you would lose your tax deductibility advantage at that point. I think it could be a could way to end-up the Smith Manoeuvre when you are about to retire.
I would suggest we wait until next year and speak to an accountant
March 1st, 2008 at 9:56 pm
CRA will allow transfers in-kind to the TFSA but will consider it a disposition. So you will be forced to realize a taxable capital gain using the asset’s market value at time of transfer. Hence no wash. “In-kind” only means you get to hold on to the asset, not that you avoid taxes.
March 2nd, 2008 at 6:07 am
let’s just hope the politicians a little further south pick up on this idea.
March 2nd, 2008 at 11:07 am
The U.S. has had the Roth IRA since 1997 as a tax-sheltered retirement savings vehicle, so Canada was way behind on this. But now Canada has leap-frogged ahead with the TFSA: contribution room isn’t “use it or lose it” (it’s carried forward indefinitely) and it offers complete withdrawal flexibility.
March 6th, 2008 at 9:23 pm
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March 18th, 2008 at 6:00 am
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