Answering your Questions on Tax Free Savings Accounts (TFSAs)

In our Winter 2009 issue we introduced TFSAs and demonstrated the difference between the returns over time in a TFSA vs. Taxable account vs. RRSP. Now that TFSAs have been in existence for some 6 months, we wanted to address some of the most common questions that our clients have

The TFSA has been described as one of the most important personal savings vehicles since the introduction of the Registered Retirement Savings Plan (RRSP). TFSA contributions grow tax-free and can be withdrawn at any time, with no restrictions on how the funds are used. Withdrawals may be used to purchase a car, renovate your home, take a family vacation or to supplement registered or education savings plans. Here are some commonly asked questions to help you get a better understanding of how these plans work:

Q. What are the key differences between an RRSP and a TFSA?

A. Some key differences include:

• Contributions to a TFSA are not tax deductible, however any withdrawals (including any investment income earned from a TFSA) are not taxed

• Contributions to TFSAs are not based on earned income and can be made after age 71

• TFSA withdrawals made in the previous year are added back to your contribution room in the following year

Q. How is TFSA contributions room calculated

A. TFSA contribution room is the sum of

• Your annual TFSA dollar limit for the current year ($5,000)

• Any unused TFSA contribution room from the previous year, and

• Any withdrawals made from the TISA in the previous year,

Unused contribution room carries forward indefinitely and any net withdrawals in a particular year are added back to your contribution room in the following year.

For example, let's assume you make a $5,000 TFSA contribution in June 2009. Then in October 2009, you make a $5,400 withdrawal ($5,000 initial contribution +investment gain of $400). For the balance of 2009, you will not be allowed to contribute to your TFSA since you will have already reached your annual contribution limit. However, in 2010, your contribution limit will be $10,400 ($5,000 as your 2010 allowable annual contribution limit +$5,400 from your withdrawal in 2009).

Q. Can I transfer investments from another institution and make an "in kind" contribution? What investments can be held in a TFSA?

A. You can make "in-kind" contributions of TFSA qualified investments generally the same investments that qualify for an RRSP You will be considered to have disposed of the property at fair market value at the time of the contribution. Therefore, you will have to report any capital gains on your tax return. However, if you incur a capital loss on the disposition, the capital loss cannot be claimed. The amount of your contribution will be equal to the fair market value of the "in-kind “property

Q. Can I designate a beneficiary for my TFSA?

A. Income earned in the TFSA after the account holder's death will generally be taxable, when distributed from the account (for example to the account holder's estate). It is possible to maintain the tax-free status of the earnings after death if you name a spouse or common law partner as the successor account holder of the TTSA. Currently, not all provinces allow for the designation of a beneficiary, as the respective provincial governments are still drafting legislation to provide for this.