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Starting in January 2009, annual contribution room of $5,000 (indexed to inflation for subsequent years) will be created for contributions which can be made to a tax-free savings account (“TFSA”) for any Canadian-resident individual who is 18 or older and who has a social insurance number. Any prior year contribution room which was not used will be carried forward, creating additional contribution room in the current year. Any withdrawals which are made from the TFSA will also be added to one’s current contribution room. Each person’s contribution room will likely be reported by the Canada Revenue Agency on the annual notice of assessment issued for one’s personal income tax return as is currently done in the case of contribution room for Registered Retirement Savings Plans (“RRSP’s”).

While the contributor does not receive a tax deduction from making a contribution to his/her TFSA, any income subsequently earned in the TFSA will be exempt from income tax, and any withdrawals from the TFSA by the owner will also be exempt from income taxes. Thus such withdrawals will not adversely affect any income-sensitive benefits, such as those received from Old Age Security, Guaranteed Income Supplements, or Employment Insurance. Since the accounts are fully tax-free, there will be no adverse income tax consequence (such as attribution of income) if a person makes a contribution on behalf of another person such a one’s spouse or child (over the age of 17).

What are the advantages in opening a TFSA? Unlike an RRSP, contribution room is not lost on withdrawal; you can subsequently recontribute amounts as long as you still have contribution room. You can achieve income-splitting among members of your family with lower income since you can make contributions to their TFSA which then earns income tax-free in their names. You can still contribute to your TFSA after you reach the age of 71 and can no longer contribute to your RRSP. The TFSA accounts has all of the advantages of any other investments in that for example it can be used as collateral for a loan.

As with RRSP, each individual can have a number of TFSA’s, but one cannot make contributions to any TFSA in excess of one’s contribution room, or else one will be subject to a penalty similar to that levied on over-contributions to RRSP’s. Similarly, interest on funds borrowed to make a contribution to a TFSA is not deductible to the contributor, nor are any service or management fees relating to the TFSA.

The investments which can be purchased and owned in a TFSA are governed by the same restrictions which apply to RRSP’s. Also one can contribute to one’s TFSA in either cash or kind. However, the transfer of a personally-owned asset to a TFSA may cause the realization of a taxable capital gain, while any capital losses realized on such transfers will be disallowed.

When one passes away, normally any subsequent earnings of the TFSA will be taxable to one’s estate or beneficiaries (though no tax will be levied on earnings accrued prior to death). However the rules involving a TFSA after the death of the annuitant are rather complex and professional advice should be sought to deal with this situation. However one can name one’s spouse or common-law partner as a successor annuitant of one’s TFSA or transfer one’s TFSA to one’s spouse on death and maintain the tax-free status of the account (without affecting the contribution room of either spouse). One can also perform the same tax-free transfer between spouses as a result of a marriage breakdown. If one later emigrates from Canada, then while the TFSA will still continue to earn tax-exempt income, one will no longer be able to make contributions to the TFSA and no additional contribution room will be created (even from subsequent account withdrawals). Of course the earnings in the TFSA may be subject to income taxes in the country where the emigrant from Canada now resides. This will apparently also be true for US citizens and green card holders who are resident in Canada, but who still file US personal tax returns by reason of their citizenship.