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Tax Free Savings Accounts – The Basics

The 2008 Federal Budget didn’t offer the tax breaks many investors had hoped for, but it did include some interesting initiatives that can help Canadians grow their savings. Many Certified Financial Planners in Canada were particularly excited about the promise of Tax Free Savings Accounts (TFSA).

The TFSA essentially amounts to an incentive to save. It is expected to benefit mainly low and middle income earners as well as seniors.

Here are some of the highlights of the Tax Free Savings Account:

- This tax sheltered savings account will allow individuals 18 years of age and older to contribute up to $5,000 annually to a Tax Free Savings Account account from 2009.

- Individuals will be allowed to carry-forward unused portions of this $5,000 allowance into future years with the annual contribution limit indexed to inflation in $500 increments.

- Contributions will not be tax deductible while capital gains or any other investment income earned within the Tax Free Savings Account will be tax exempt. Withdrawals from a Tax Free Savings Account will be tax free.

- Qualified investment for a Tax Free Savings Account will be similar to those allowed for under a qualified RRSP, including stocks, bonds and mutual funds.

- Spousal contributions are allowed, up to the contributor’s maximum limit of $5,000.

RRSP or TFSA?

Choosing between a Tax Free Savings Account and a qualified RRSP will depend on your specific situation and needs.

RRSPs may make more sense if the tax rate at withdrawal is expected to be lower than the tax rate at the point of original contribution. Investors can use a Tax Free Savings Account to save for specific needs. Seniors over 71, who no longer qualify for contributions to RRSPs, can use a Tax Free Savings Account to supplement a retirement savings plan.