Lots of pros with a TFSA - and few cons

The TFSA (Tax Free Savings Account) was introduced in 2009. It allows Canadians over 18 years of age to contribute $5,000 a year throughout their lifetimes.

From 2012 on the $5,000 limit will rise, if warranted by inflation, in $500 increments. Contributions to the account are not tax deductible, but interest, dividends and capital gains accumulate on a tax free basis.

Withdrawals of both earnings and principal are tax exempt. All withdrawals will make new contribution room, on an indefinite carry forward basis.

The only restriction here is that the withdrawal cannot be put back into the TFSA in the same calendar year.

A Tax Free Savings Account can provide some interesting new savings opportunities for family members.

Here are several strategies that may benefit you:-

Used for Family Income Splitting

No attribution rules apply to the contributions in Tax Free Savings Accounts. This makes it simpler for parents and grandparents to transfer $5000 per year to each adult child in the family indefinitely.

Recipients can take the money out for whatever purpose they wish and create new contribution room.

Compared to Home Buyers Plan (HBP)

Money withdrawn from the Home Buyers Plan to purchase a new home is non taxable, however, it has to be repaid within a certain period of time, otherwise it is taxable.

Withdrawals from a Tax Free Savings Account, on the other hand, are exempt from taxation. It may make more sense to accumulate your savings there when planning to buy a house.

Compared to Lifelong Learning Plan (LLP)

Withdrawals under the LLP are also tax-free but require an annual repayment schedule. Again, it may make more sense to accumulate your savings in a Tax Free Savings Account.

Registered Education Savings Plan (RESP) Still Favourite

Withdrawals under an RESP are taxable in the hands of the recipient (usually the student) and little or no tax consequences arise.

The government contributes 20% of the contributions inside an RESP up to a maximum of $500, whereas no such contributions are made to Tax Free Savings Account.

In this case, accumulating education funds for children inside an RESP is more advantageous.

For Side Stepping Pension Contribution Limitations

Contributors to employer pension plans are often precluded from making RRSP contributions because of their pension adjustment amount.

They now have the opportunity to tap into a tax free savings opportunity in a Tax Free Savings Account. So do those who have contributed the maximum to an RRSP and want to do more to supplement their savings.

Presenting New Tax Sheltering Opportunity For Other Income

People receiving pension benefits, investment interest and employment insurance benefits can’t use them as income for RRSP contribution purposes.

They now have an opportunity for tax sheltered retirement savings.

Providing New Estate Planning Considerations

The TFSA loses its tax-exempt status after the death of the plan holder, meaning that the investment income will become taxable.

However, a rollover opportunity is possible when the spouse or common-law partner becomes the successor.

This will not affect the spouse's contribution room in any way.

Its impact on Divorce or Separation  

Funds can be transferred from the Tax Free Savings Account of one party in the split of a marriage or common law relationship to the other, on a no-penalty basis.

The transfer, in this case, will not create contribution room for the transferring party but it will not affect the contribution room of the receiving party.

Tax Implications

Since interest income is taxed at full marginal tax rate, it makes sense to shelter interest bearing vehicles in Tax Free Savings Accounts. This is useful for seniors and conservative investors with investments like GICs.

An OAS claw-back may be triggered by grossed-up dividend income. In such a case it may be prudent to place your dividend paying stock in a Tax Free Savings Account.

Capital losses realized inside a TFSA cannot be claimed against capital gains outside of it. Since capital gains can be deferred by careful investing, a Tax Free Savings Account may not be the best choice.

Getting Started with your TFSA 

You can open a TFSA if you are a Canadian resident who has reached the age of eighteen.


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