Tax-Free Savings Account
Encyclopedia
The Tax-Free Savings Account (TFSA) is an account that provides tax
benefits for saving in Canada
. Contributions to a TFSA are not deductible for income tax purposes. Investment income, including capital gains, earned in a TFSA is not taxed, even when withdrawn.
, Canadian
federal Minister of Finance
, in the 2008 federal budget
. It was a significant measure in the budget and came into effect on January 1, 2009.
This measure was supported by the C.D. Howe Institute: “This tax policy gem is very good news for Canadians, and Mr. Flaherty and his government deserve credit for a novel program”,, the Canadian Federation of Independent Business, Canadian Bankers Association, Bank of Montreal
economist Doug Porter, the Canadian Chamber of Commerce, and the Canadian Taxpayers Federation.
. The interest-income will be able to compound tax-free. In essence, the account-holder can withdraw any amount out of the account, free from capital gains and/or withdrawal taxes.
One mechanism in the design of the TFSA is the carry-over aspect. Any unused space under the $5,000 cap can be carried forward to subsequent years, without any upward limit. The TFSA also allows income splitting
to an extent, because a higher-earning spouse can contribute to the TFSA of a lower-earning spouse.
The $5,000 annual contribution limit will be indexed to the Consumer Price Index
(CPI), in $500 increments, in order to account for inflation
.
(RRSP). For RRSPs, there is a tax deduction for contributions to a RRSP, and withdrawals of contributions and investment income are all taxable. In contrast, there is no tax deduction for contributions to TFSA, and there is no tax on withdrawals of investment income or contributions from the account. Up to $5,000 per year can be placed into a TFSA. This money can then be withdrawn at any point of time, without penalty. Unlike RRSP’s, which must be withdrawn before the holder turns 71, the TFSA does not expire. The contribution room for funds withdrawn from a TFSA is reallocated in the tax year after the withdrawal, unlike an RRSP, where the contribution room is permanently reduced once a contribution is made.
The Canada Revenue Agency
(CRA) describes the difference between a TFSA and an RRSP as follows: "An RRSP is primarily intended for retirement. The TFSA is like an RRSP for everything else in your life."
As a result of this mailing, financial institutions received many calls from confused clients. The TFSA holders did not realize that withdrawals from the TFSA increase the available contribution room not in the current calendar year, but the next calendar year.
For example, if you contributed $5,000 to a TFSA in January 2009, withdrew it all in July, and then later recontributed the $5,000 in November 2009, this would put you in an overcontribution position because the $5,000 July withdrawal does not create further room until 2010. This rule has caused much confusion.
The CRA recommended taxpayers still send in their payment penalty with the TFSA return and a letter explaining the situation by June 30th, 2010. The CRA stated it would review this information on a case by case basis. If relief was granted, the CRA said they would return the payment. As of June 2010, the CRA has received about 10,000 responses to its letter from taxpayers.
TFSA holders can wait until they receive a Notice of Assessment, expected to be issued in August 2010, and then either file a formal Notice of Objection or apply for administrative relief by writing to the CRA. The risk of waiting, however, is that a late-filing penalty as well as interest may be charged by the CRA.
s in United States . In the UK, similar tax advantages have been available in Individual Savings Account
s since 1999.
Tax
To tax is to impose a financial charge or other levy upon a taxpayer by a state or the functional equivalent of a state such that failure to pay is punishable by law. Taxes are also imposed by many subnational entities...
benefits for saving in Canada
Canada
Canada is a North American country consisting of ten provinces and three territories. Located in the northern part of the continent, it extends from the Atlantic Ocean in the east to the Pacific Ocean in the west, and northward into the Arctic Ocean...
. Contributions to a TFSA are not deductible for income tax purposes. Investment income, including capital gains, earned in a TFSA is not taxed, even when withdrawn.
History
It was introduced by Jim FlahertyJim Flaherty
James Michael "Jim" Flaherty, PC, MP is Canada's Minister of Finance and he has also served as Ontario's Minister of Finance. From 1995 until 2005, he was the Member of Provincial Parliament for Whitby—Ajax, and a member of the Progressive Conservative Party caucus...
, Canadian
Canada
Canada is a North American country consisting of ten provinces and three territories. Located in the northern part of the continent, it extends from the Atlantic Ocean in the east to the Pacific Ocean in the west, and northward into the Arctic Ocean...
federal Minister of Finance
Minister of Finance (Canada)
The Minister of Finance is the Minister of the Crown in the Canadian Cabinet who is responsible each year for presenting the federal government's budget...
, in the 2008 federal budget
2008 Canadian federal budget
The Canadian federal budget for the 2008-2009 fiscal year was presented to the Canadian House of Commons by Finance Minister Jim Flaherty on February 26, 2008....
. It was a significant measure in the budget and came into effect on January 1, 2009.
This measure was supported by the C.D. Howe Institute: “This tax policy gem is very good news for Canadians, and Mr. Flaherty and his government deserve credit for a novel program”,, the Canadian Federation of Independent Business, Canadian Bankers Association, Bank of Montreal
Bank of Montreal
The Bank of Montreal , , or BMO Financial Group, is the fourth largest bank in Canada by deposits. The Bank of Montreal was founded on June 23, 1817 by John Richardson and eight merchants in a rented house in Montreal, Quebec. On May 19, 1817 the Articles of Association were adopted, making it...
economist Doug Porter, the Canadian Chamber of Commerce, and the Canadian Taxpayers Federation.
Benefits
The TFSA is an investment option for Canadian residents 18 years and older wanting to save for the future. The TFSA's flexible structure allows the holder to be able to withdraw money from the account at any time, free of taxes. The allocations into the account are non-deductible; however this represents a lucrative opportunity for individuals with left-over income to invest in a savings vehicle, without the pressure of time constraints. The account also alleviates the burden of the capital gains taxCapital gains tax
A capital gains tax is a tax charged on capital gains, the profit realized on the sale of a non-inventory asset that was purchased at a lower price. The most common capital gains are realized from the sale of stocks, bonds, precious metals and property...
. The interest-income will be able to compound tax-free. In essence, the account-holder can withdraw any amount out of the account, free from capital gains and/or withdrawal taxes.
One mechanism in the design of the TFSA is the carry-over aspect. Any unused space under the $5,000 cap can be carried forward to subsequent years, without any upward limit. The TFSA also allows income splitting
Income splitting
Income splitting is the legal concept of fusing a married couple into a single economic entity for purposes of tax filing status. It would treat married people preferentially, in the same sense they are treated preferentially in many areas of American state law as well as federal inheritance...
to an extent, because a higher-earning spouse can contribute to the TFSA of a lower-earning spouse.
The $5,000 annual contribution limit will be indexed to the Consumer Price Index
Consumer price index
A consumer price index measures changes in the price level of consumer goods and services purchased by households. The CPI, in the United States is defined by the Bureau of Labor Statistics as "a measure of the average change over time in the prices paid by urban consumers for a market basket of...
(CPI), in $500 increments, in order to account for inflation
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
.
How TFSAs differ from RRSPs
In a sense the tax treatment of a TFSA is the opposite of a Registered Retirement Savings PlanRegistered Retirement Savings Plan
A Registered Retirement Savings Plan or RRSP is a type of Canadian account for holding savings and investment assets. Introduced in 1957, the RRSP's purpose is to promote savings for retirement by employees. It must comply with a variety of restrictions stipulated in the Canadian Income Tax Act...
(RRSP). For RRSPs, there is a tax deduction for contributions to a RRSP, and withdrawals of contributions and investment income are all taxable. In contrast, there is no tax deduction for contributions to TFSA, and there is no tax on withdrawals of investment income or contributions from the account. Up to $5,000 per year can be placed into a TFSA. This money can then be withdrawn at any point of time, without penalty. Unlike RRSP’s, which must be withdrawn before the holder turns 71, the TFSA does not expire. The contribution room for funds withdrawn from a TFSA is reallocated in the tax year after the withdrawal, unlike an RRSP, where the contribution room is permanently reduced once a contribution is made.
The Canada Revenue Agency
Canada Revenue Agency
The Canada Revenue Agency is a federal agency that administers tax laws for the Government of Canada and for most provinces and territories, international trade legislation, and various social and economic benefit and incentive programs delivered through the tax system...
(CRA) describes the difference between a TFSA and an RRSP as follows: "An RRSP is primarily intended for retirement. The TFSA is like an RRSP for everything else in your life."
Eligible investments
A TFSA can hold any investments that are RRSP eligible, including: publicly traded shares on eligible exchanges, eligible shares of private corporations, certain debt obligations, installment receipts, money denominated in any currency, trust interests including mutual funds and real estate investment trusts, annuity contracts, warrants, rights and options, registered investments, royalty units, partnership units, and depository receipts.Overcontributions
On June 1, 2010, the Canada Revenue Agency (CRA) mailed about 72,000 overcontribution letters to TFSA holders, representing about 1.5% of all 4.7 million TFSA-holders. The letters and calculations were based on information CRA received from financial institutions.As a result of this mailing, financial institutions received many calls from confused clients. The TFSA holders did not realize that withdrawals from the TFSA increase the available contribution room not in the current calendar year, but the next calendar year.
For example, if you contributed $5,000 to a TFSA in January 2009, withdrew it all in July, and then later recontributed the $5,000 in November 2009, this would put you in an overcontribution position because the $5,000 July withdrawal does not create further room until 2010. This rule has caused much confusion.
The CRA recommended taxpayers still send in their payment penalty with the TFSA return and a letter explaining the situation by June 30th, 2010. The CRA stated it would review this information on a case by case basis. If relief was granted, the CRA said they would return the payment. As of June 2010, the CRA has received about 10,000 responses to its letter from taxpayers.
TFSA holders can wait until they receive a Notice of Assessment, expected to be issued in August 2010, and then either file a formal Notice of Objection or apply for administrative relief by writing to the CRA. The risk of waiting, however, is that a late-filing penalty as well as interest may be charged by the CRA.
Similar accounts in other countries
The TFSA is similar to Roth IRARoth IRA
A Roth IRA is a special type of retirement plan under US law that is generally not taxed, provided certain conditions are met. The tax law of the United States allows a tax reduction on a limited amount of saving for retirement. The Roth IRA is named for its chief legislative sponsor, Senator...
s in United States . In the UK, similar tax advantages have been available in Individual Savings Account
Individual Savings Account
An Individual Savings Account is a financial product available to residents in the United Kingdom. It is designed for the purpose of investment and savings with a favourable tax status. Money is contributed from after tax income and not subjected to income tax or capital gains tax within a holding...
s since 1999.
See also
- Taxation in CanadaTaxation in CanadaThe level of Taxation in Canada is average among Organisation for Economic Co-operation and Development countries.-Administration:...
- Registered Retirement Savings PlanRegistered Retirement Savings PlanA Registered Retirement Savings Plan or RRSP is a type of Canadian account for holding savings and investment assets. Introduced in 1957, the RRSP's purpose is to promote savings for retirement by employees. It must comply with a variety of restrictions stipulated in the Canadian Income Tax Act...
- Registered Education Savings PlanRegistered Education Savings PlanA Registered Education Savings Plan, or RESP, is an investment vehicle used by parents to save for their children's post-secondary education in Canada. The principal advantages of RESPs are the access to the Canada Education Savings Grant and a source of tax-deferred income.-Tax Benefits:An RESP...