The Federal Government has introduced a new registered savings account that allows taxpayers to earn investment income tax-free.  The Tax-Free Savings Account (TFSA) is available beginning in 2009 to Canadian Residents age 18 or older. TFSA allows taxpayers to set money aside in eligible investment vehicles and watch those savings grow tax-free throughout their lifetime.

There are no restrictions on the way TFSA funds (contribution earnings) may be used (i.e. purchase a car, renovate a home, start a small business, take a family vacation, or just save for ‘a rainy day’).  All income levels and all walks of life can benefit from a TFSA.  But only a careful review of each person’s financial situation will determine how to optimize use of RRSPs, RESPs, RRIFs and TFSAs.

Types of TFSAs

Prosperity ONE provides TFSAs in three basic types:

• Variable interest savings account (similar to our Investment Savings account)
• GICs (including Escalator and Index-Linked term deposits)
• *Mutual funds

While all TFSAs provide the same benefits, not all plans are the same.  Prosperity ONE offers a variety of ways invest your money under the TFSA umbrella. Growth rates, terms, conditions, availability of deposit insurance, and fees may vary depending on the TFSA investments that are best for you.

TFSA Eligibility

The individual owning the TFSA is the ‘Holder’.  Any individual person (not trusts or corporations) who meets all of the following three requirements is eligible to open a TFSA:

• Resident in Canada, and
• 18 years of age or older, and
• Holds a valid Social Insurance Number (SIN)

There is no maximum age limit to open or hold a TFSA and a person may hold more than one TFSA.

TFSA Contribution Limit

Contributions to a TFSA may only be made by the Holder and the amount is not tied to the income of the Holder.

• $5,000 is the maximum TFSA contribution limit for each year beginning in 2009
• After 2009, the $5,000 maximum contribution limit may be increased depending on the rate of inflation; rounded to the nearest $500 e.g. if the rate of inflation in 2009 is 5.1%, in 2010, the maximum would increase to $5,500 ($5,000 x 5.1% = $255; nearest to $500 is $5,500). Therefore the limit will increase some years, but not every year
• Contributions are not tax deductible

NOTE:  The holder is responsible for ensuring the maximum contribution limit is not exceeded.  An excess contribution will result in a penalty tax of 1% per month for each month that the excess contribution amount remains in the TFSA.

TFSA Unused Contribution Room

When a TFSA Holder contributes less than the maximum contribution limit, the difference is referred to as ‘unused contribution room’.

• Unused contribution room will accumulate each year
• Unused contribution room is carried forward indefinitely allowing the Holder to ‘catch up’ by contributing more than the maximum contribution limit in a future year
• A TFSA withdrawal will increase the contribution room for the year after withdrawal.  As a result, when amounts are withdrawn from a TFSA they can be re-contributed in the future when funds become available
• Canada Revenue Agency will confirm the contribution room on the annual Notice of Assessment

NOTE:  Individuals who do not have taxable income and who do not file a tax return do not receive the annual CRA Notice of Assessment.  Those individuals should file a NIL T1 Tax Return so CRA can issue a Notice of Assessment that confirms the TFSA contribution room. 

Borrowing Money to Purchase a TFSA

Interest on money borrowed to purchase a TFSA is not deductible for tax purposes.

Benefits and Advantages

Benefits or advantages based on TFSA holdings, such as merchandise, trips or interest-free loans, are subject to a penalty tax.  All benefits must go into the TFSA, not to the Holder or a person with whom the Holder is not dealing at arm’s-length. 

Withdrawals

• TFSA Holder may withdraw funds at any time; withdrawals may be restricted by investment terms
• Withdrawals are not reported as taxable income and are not subject to income tax
• TFSA withdrawals of contribution/earnings will increase contribution room for future years, but not the current year
• Withdrawals will not impact eligibility for federal income tested benefits and credit (e.g. OAS, GIS, Age Credit, GST, EI, child-tax benefit, working income tax benefit).

Transfers

• TFSA is transferable to another TFSA  owned by the Holder; transfers may be restricted by investment terms
• Transferable to a spouse/common-law partner on death of the Holder
• Transferable to a former spouse/common-law partner on relationship breakdown

NOTE:  A transfer due to death will not affect the TFSA contribution room of the surviving spouse/common-law partner.  A transfer due to relationship breakdown will not affect the TFSA contribution room of the Holder or former spouse/common-law partner.

Death of a TFSA Holder

A TFSA Holder may appoint his/her spouse/common-law partner as successor holder and beneficiary of the TFSA.  Upon death of the Holder, the spouse/common-law partner will become the Holder of the TFSA.  Alternatively, the surviving spouse/common-law partner may transfer the funds to a new or existing TFSA in his/her name.  There will be no impact on the TFSA contribution room of the surviving spouse/common-law partner.

The Holder may designate someone other than the spouse/common-law partner as beneficiary of the TFSA, or may choose not to name any beneficiary at all.  In either circumstance, the fair market value (FMV) of the TFSA at date of death is tax-free.  Any increase in value of the TFSA after date of death becomes taxable income either of the beneficiary or of the deceased’s estate, depending on the circumstances and the date of payments.

Non-resident Holder

When a Holder is no longer a resident of Canada, the following rules apply:

• The TFSA may remain open
• No contributions may be made
• Non-resident Holder will not accumulate contribution room
• Withdrawals will not increase contribution room
• If a non-resident Holder makes a contribution, the Holder is subject to a 1% per month penalty tax for each month that the contribution remains in the TFSA

If the Holder becomes a resident of Canada, contribution room will commence accruing and the Holder may make future contributions.

*Mutual funds are offered through Credential Asset Management Inc. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Unless otherwise stated, mutual fund securities and cash balances are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer that insures deposits in credit unions. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.