The new Tax-Free Savings Account introduced yesterday will help you earn more on your savings and investments by eliminating tax.
Prediction: If the government gets this budget passed, TFSAs will become ubiquitous in a few years. Even though the tax savings aren't dramatic, most households will have at least a few of these plans.
The TFSA is the sort of measure you rarely see introduced. It's simple to understand, almost universally applicable and free of restrictive rules.
Starting in 2009, Canadians 18 and older will be able to put up to $5,000 a year in a TFSA and rack up investment gains without paying taxes on them at any time, including withdrawal.
You don't get a tax deduction for contributing money to a TFSA as you do with a registered retirement savings plan, but the ability to invest in almost anything and be free of taxes is a huge offset.
TFSAs will be like RRSPs in that they're designed as an administrative label that can be attached to most any kind of investment, including stocks, mutual funds, bonds, guaranteed investment certificates and savings accounts.
The Finance Department envisions TFSAs as a complement or add-on to the RRSP, which is used to accumulate money to live on after you leave the work force. The TFSA, as the budget documents say, "is like an RRSP for everything else."
Saving for a car? You can drop $5,000 into a TFSA, invest safely in a high-interest savings account and then withdraw the money any time you want without paying a cent in taxes. Once you've pulled your $5,000 out, you can recontribute that money at any time. Likewise, you can catch up on contributions you didn't make in previous years, and you can contribute to a spouse's plan.
TFSAs will have a lot of appeal to people in their prime spending years. But the Finance Department expects that seniors will receive half the benefits of this plan because it will be an attractive place to invest funds they pull out of their retirement savings and don't need to cover living expenses. Seniors will be relieved to know that money withdrawn from a TFSA won't affect their eligibility to receive Old Age Security.
The TFSA will come as a serious disappointment to investors hoping the federal government would follow through on its election promise to provide a tax exemption on capital gains that are reinvested in six months. If you looked forward to being able to sell the family cottage and avoid taxes by reinvesting the money, the $5,000-a-year TFSA allowance won't cut it.
TFSAs will benefit a lot more people than the capital gains exemption, although the total cost to the federal government in lost taxes will be far less. If you invested the full $5,000 in a high-interest savings account paying 4 per cent, you'd pay $80 a year in taxes if you assume a 40-per-cent tax rate. In a TFSA, your tax bill would be zero. Those are modest savings, but they'll be welcome at this time of year when those tax slips roll in to tell us how much we owe on our savings and investments.
TFSAs will be administered in a way that's similar to registered investments like RRSPs and RESPs, and they'll be offered by banks, life insurers, credit unions and trust companies. Don't be surprised if these financial institutions charge annual administration fees for these plans, as they do for RRSPs and registered education savings plans.
You'll have a lot of freedom to invest using a TFSA, but the most obvious application is for the savings accounts that many people use to hold emergency funds or money to be used for a big expenditure like a car or home. Interest paid by these accounts is taxed at the highest rate, so the sheltering provided by a TFSA would be especially welcome.
Here are some other budget developments of interest to savers and investors:
The flexibility of RESPs is to be improved through measures that would allow them to remain open for 35 years, up from 25, and allow contributions to be made over a maximum of 31 years, up from 21.
The taxes individual investors pay on corporate dividends will rise slightly over the next four years to adjust for changes in corporate income tax.
Rules for Life Income Funds - they hold money taken out of pension plans when you leave a company - are being relaxed to make it easier to withdraw money.
Tax-free savings account
Capital gains and other investment income earned in a TFSA will not be taxed and withdrawals from the account are tax free.
CONTRIBUTING $200 A MONTH FOR 20 YEARS:
| Contributions | Investment income* | Tax savings | |
| Taxable | $48,000 | $28,480 | |
| Non-taxable | $48,000 | $39,525 | $11,045 |
*Based on a 5.5 per cent rate of return. For unregistered savings,
a 21-per-cent average tax rate is assumed.
SOURCE: BUDGET 2008
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