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Canadian Tax-Free Savings Account (TFSA)

Tax Free Savings Account

Canadian residents, age 18 and over, have a new incentive to save money, without having to pay tax on the interest it earns. The tax-free savings account (TFSA) allows you to contribute up to $5,000 annually, with $500 increments indexed to inflation. The money you contribute is not tax-deductible, but the income earned from any capital gains, interest, dividends, or other investment income within these accounts will be tax-free.

In addition, the savings account will allow you to:

  • Make tax-free withdrawals that add to your contribution room for the next year.
  • Protect any TFSA earnings from affecting any benefits that are based on income.
  • Contribute to a spouse or common law partner's TFSA.

RRSP vs. TFSA: Saving for the Future

Financial institutions currently issuing RRSPs are also able to issue TFSAs. TFSAs differ from RRSPs in that tax benefits on RRSPs usually prevent the withdrawing of money until retirement. TFSAs, with $5,000 annual contribution limit, will not allow you to save enough for retirement. If you expect that your tax rate will be lower when you retire, RRSPs will actually be more beneficial in the long-term.

In regards to using your RRSPs toward the Home Buyers' Plan (HBP), which is designed to assist first-time homebuyers with a means of acquiring cash for a down payment, the new tax-free account does present some advantages, especially to those saving toward a second property.

Below is a comparison table between the RRSP HBP and the new tax-free savings account:

RRSP Home Buyers Plan Tax-free Savings Account
Availability First-time buyers Everyone
Money Taxed Upon withdrawal from RRSP1 Before depositing into TFSA
Tax Deductible Deposits Yes No
Withdrawals Must be paid back No Need to Repay
Maximum Annual Deposit
(for 2008)
$20,000 (max. 19% of your income) $5,000
Maximum Withdrawal $20,000 Unlimited
1. Money withdrawn under the Home Buyers' Plan is tax-free if repaid in 15 equal yearly instalments.

TFSAs for Major Purchases

Because they allow the flexibility of tax-free withdrawals, re-contribution at any time, and accrue tax-free interest, TFSAs are ideal to use to save up for a large purchase such as an overseas vacation, tuition fees or a down payment on a home. For example: Contributing $200 per month to a TFSA over 20 years will accumulate about $11,045, more than submitting the same contributions would amount to in an unregistered account.

Tax Free Savings Graph

Notes: Combined federal-provincial tax savings, based on a $200 monthly contribution for 20 years and a 5.5 per cent rate of return. For unregistered savings, a 21 per cent average tax rate on investment income is assumed (based on 40 per cent interest, 30 per cent dividends and 30 per cent capital gains, and a middle-income earning account holder).
Source: Department of Finance Canada

Open a TFSA With Your Mortgage Savings

If you want to take advantage of the tax-free savings account, but currently lack access to the funds to contribute to one, consider refinancing your mortgage. Canequity offers the best interest rates available. With one of our many fixed rate mortgage products, you could save close to one year's TFSA contribution limit, and begin amassing tax-free earnings.

Savings Account

Note: Amounts expressed in constant dollars and investments assumed to earn a real rate of return of 3.5 per cent (5.5 per cent nominal minus 2 per cent inflation). Tax Savings calculated using an average combined federal-prvincial tax rate of 21 per cent on investment income, consistent with middle-income earner investing in a balanced portfolio (40 per cent interest, 30 per cent dividends and 30 per cent capital gains).
Source: Department of Finance Canada
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