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Tax Free Savings Accounts: What You Need to Know

By Mario Cywinski |

In today's world it can sometimes seem as though everything is taxed in one way or another. From purchases made at the store, to the money made by a business, to the money kept in savings accounts.

Registered Retirement Savings Plans (RRSP) are a good idea to save for retirement, but they are not flexible and are subject to taxes if they are withdrawn before a certain time.

Beginning January 1, 2009, the option of having that nest egg not be depreciated by taxes will become a reality when new Tax-Free Savings Accounts (TFSA) will be introduced.

While the TSFA was introduced in the House of Common as part of Budget 2008 on February 26, 2008, many Canadians still know very little about it. Bringing this point home is the fact that only 46 per cent of Canadians plan on opening a TFSA, with 17 per cent planning on contributing the maximum amount, according to a survey conducted by Investors Group Inc.

"The TFSA presents Canadians with an opportunity to reduce taxes and use their savings with greater flexibility," said Debbie Ammeter, Vice President, Advanced Financial Planning Support at Investors Group. "It's worth learning more about the TFSA and incorporating it into your overall investment strategy."

So what exactly is the TFSA?

The TFSA is meant to allow Canadians over the age of 18 to contribute up to $5,000 a year into a saving account that is not taxed by the federal government. This means that it does not cost anything to withdrawal the money at anytime. Conversely, contributions made to the TFSA are not tax deductable, as RRSPs are.

Even though a limit of $5,000 per year is in place, any unused amounts can be carried forward to the following year. Therefore, if only $1,000 is contributed for the first five years, a total of $20,000 worth of contribution room will still be available. So someone wishing to add $25,000 in the sixth year can do so.

To make it easier for married or common-law couples to save, income attribution rules will not apply and a spouse can help to contribute into a TFSA. In the unfortunately event of a death, the TFSA can be transfers to the spouse. This is where the TFSA differs from an RRSP, as money cannot be directly contributed to a spouses account.

Many government social programs such as the Canada Child Tax Benefit, GST credit, Old Age Security and Guaranteed Income Supplement benefits will not be affected by a TFSA, as the contributions will not count towards these.

"The magic behind the TFSA is in its versatility. It is not simply a tax measure designed to help low-income Canadians, but rather a vehicle that can fit almost every Canadian, regardless of income or stage of life," said Benjamin Tal, Senior Economist at CIBC World Markets.

Business can use TFSAs to enhance employee benefit packages

While the TFSA is aimed mainly at individuals, businesses can also get in on the action. The main way to do this is by adding a TFSA to employee benefits packages.

"Forty-three per cent of employers indicated they were either likely or highly likely to add a TFSA to their employee benefits program," said Mazen Shakeel, a senior retirement consultant with Hewitt Associates. "Another 45 per cent were unsure, but hadn't ruled out adding a TFSA."

TFSA includes the term 'savings account' but are much more flexible. While the option to have contributions grow with a standard savings rate is a start, the money can also be used towards mutual funds, GICs or term deposits.

"The TFSA is the most significant incentive for Canadians to save since the introduction of Registered Retirement Savings Plans (RRSPs)," said Dean Connor, President, Sun Life Financial Canada. "Every Canadian can benefit from this flexible account, from saving for a down payment on a home to providing additional income for retirement."

TFSAs expected to co-exist with RRSPs

On the face it may seem like a TFSA is meant to compete with a RRSP. However, it is hoped that they can co-exist. Only 21 per cent of Canadians surveyed suggested that they will divert money away from there RRSP to place it in a TFSA.

For those wishing to view the tax savings on the new TFSA versus a regular saving account can use the Budget 2008's calculator,

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