In the federal budget introduced on February 26, 2008 the Finance Minister proposed a tax-free savings account starting in 2009. The so-called TSFA would be a registered plan into which Canadians over the age of 18 could contribute $5,000 annually. The contributions would not be tax deductible but the investment income, whether interest, dividends or capital gains, would be tax exempt within the plan and would not be taxed at withdrawal.

Every Canadian over 18 would have $5,000 contribution room each year and any unused contribution room could be carried forward indefinitely, without limit. Any withdrawals from the plan in the year would then be added back to your contribution room for the following year. Therefore if you invested $5,000 into a TSFA in 2009 and withdrew $2,000 in that year for any reason, your contribution room for 2010 would be $7,000. Therefore you would maintain your cumulative contribution room at $10,000. Over contributions, though, would be taxed at 1% a month.

As these Tax-Free Saving Accounts would be registered accounts, they would be allowed to invest in many of the same investments as an RRSP. Like an RRSP, interest on money borrowed to invest into a TSFA would not be tax deductible, but unlike an RRSP there would be no prohibitions on using the TSFA as collateral for a loan.

Other features of the plan include an exception to the “attribution rule” which governs the transferring of property from spouse to spouse. Whereas income tax rules 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 would be considered belonging to the owner of that plan. This would therefore make it an ideal vehicle for "income splitting” between spouses or partners.

An individual’s TFSA would lose its tax exempt status upon the individual’s death: however, any investment or gains accrued before the individual’s death would remain tax exempt. You could name your spouse or common-law partner as successor account holder, and the account would keep its tax-exempt status. The TFSA would then be transferred to the surviving spouse whether or not he or she had available contribution room and without reducing his or her existing contribution room.

In the event of divorce or separation, funds from the TFSA could be transferred to either the spouse or partner. The transfer would not re-instate the contribution room of the transferor and would not count against the contribution room of the transferee.

Individuals who became non-residents could maintain their TFSA and could continue to benefit from the tax exempt status on withdrawals, but would not be permitted to make any new contributions or accrue additional contribution room while they had non-resident status.

Withdrawals from a TFSA would not be taken into account when determining other benefits that are based on an individual’s income level like Old Age Security benefits, Guaranteed Income Supplement and Employment Insurance benefits. Neither would they be eligible for income-tested benefits or credits, such as the Canada Tax Credit Benefit or the Goods and Services Tax Credit.

Sound good? Well, the budget still has to be passed for the Tax Free Savings Account to come into effect in 2009.

March 5, 2008