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Tax-Free Savings Account (TFSA)

As mentioned in the first blog entry of February 29, 2008, the February 26, 2008 Federal Budget introduced the TFSA. The new TFSAs appear to be similarly modeled after “Roth IRAs” that exist in the US. On the surface, the introduction of this vehicle does not appear to be all that earth shattering. However, upon a closer look, some significant planning may be able to be done.

The TFSA is a registered savings account that ultimately will enable taxpayers to contribute annual contribution amounts (any unused contribution room can be carried forward to another year) with such contribution not being tax deductible. However, any investment income inside the account will always be tax free. Any withdrawals from the TFSA including the realized investment income are also tax free and will increase the contribution limit for future years by the amount of such withdrawal. The annual contribution limit is scheduled to be $5,000 for 2009 and annually indexed to inflation thereafter.

Given the relatively low contribution amounts, it would appear that this vehicle is aimed specifically at lower to middle income earners so as to encourage them to contribute such amounts and thereby build up savings for their future retirement. From a policy perspective, this would seem to make sense so as to encourage taxpayers to not rely on the Government’s social safety nets.

However, higher net worth persons may also take advantage of such TFSAs by perhaps putting their higher risk capital in a TFSA so as to realize larger gains tax free. Given that the TFSA will always be tax free (except the TFSA will lose its tax free status upon the death of the taxpayer) such a TFSA may be a great vehicle to realize tax free amounts. However, for US citizens who are resident in Canada, caution will need to be exercised since it is highly likely that the US Internal Revenue Service will not respect the tax-free nature of the TFSAs.

The Canada Revenue Agency has recently released a document on the new TFSAs and can be found here.

Keep your ears to the ground—it looks like good planning may occur as a result of the introduction of these rules.