In the years to come, we may very well look back on the 2008 federal budget as the event that changed the way we invest.
Starting in 2009 every person 18 or older may contribute up to $5,000 annually to a Tax-Free Savings Account, or TFSA, touted by the government as a “flexible, registered general-purpose account that will allow Canadians to earn tax-free investment income.”
As with an RRSP, a TFSA operates as a tax shelter while funds remain in the plan. Where a TFSA differs is at contribution and withdrawal times:
- An RRSP provides a tax deduction when you contribute, but funds are fully taxable upon withdrawal
- A TFSA is funded with after-tax money, but all withdrawals are 100% tax-free
The $5,000 limit is indexed annually, is not affected by a person’s income (as is the case with RRSP room), and any unused room may be carried forward indefinitely.
What’s more, those non-taxable TFSA withdrawals directly recover contribution room dollar-for-dollar. A TFSA can therefore be accessed, replenished and re-accessed as your life circumstances change.
There is no forced conversion into a RRIF-type depletion plan; you can keep the money invested as long as you want, and there is no tax at death.
In terms of ultimate after-tax dollars, if a person expects to be at the same tax rate on contribution and withdrawal, an RRSP or TFSA will yield the same result. Where there is a rate differential, however, choices may be affected: High-to-low favours the RRSP, whereas low-to-high favours the TFSA.
As well, there are some other interesting TFSA features that may influence the decision:
- Withdrawals have no effect on income-tested tax credits such as the Canada Child Tax Benefit or the Goods and Services Tax Credit, nor will they cause a clawback of government income sources such as the Guaranteed Income Supplement or even Old Age Security benefits.
- For wealthy couples tired of working around the spousal attribution rules affecting both open investments and spousal RRSPs, TFSA contributions are specifically exempted from those anti income-splitting rules
While 2009 may seem a while off, strategically it may be prudent to revisit your financial plan today in order to accommodate for this new future. “What” to invest in still comes down to sound investment choices. “How” to invest just got a lot more interesting.