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tax free savings account

Tax-Free Savings Account

The Tax Free Savings Account or TFSA was introduced by Jim Flaherty, Canadian federal Minister of Finance, in Budget 2008. It was a significant measure in the budget and will be coming into effect on January 1st, 2009. The TFSA is an investment option for individuals wanting to save for the future. The TFSAs’ flexible structure allows the holder to be able to withdraw money from the account at any time, free of taxes. The allocations into the account are non-deductible; however this represents a lucrative opportunity for individuals with left-over income to invest in a savings vehicle, without the pressure of time constraints. The account also alleviates the burden of the capital-gains tax. The interest-income will be able to compound tax-free. In essence, the account-holder can withdraw any amount out of the account, free from capital gains and/or withdrawal taxes.

The Tax-Free Savings Account works like the opposite of a Registered Retirement Savings Plan or RRSP. After-tax income of up to $5,000 per year can be placed into a TFSA. This money can then be withdrawn at any point of time, without penalty. Unlike RRSP’s, which must be withdrawn after the holder turns 71, the TFSA does not expire.

One mechanism in the design of the TFSA is the carry-over aspect. Any unused space under the $5,000 cap can be carried forward to subsequent years, without any upward limit. The TFSA also allows income splitting to an extent, because a higher-earning spouse can contribute to the TFSA of a lower-earning spouse.

The $5,000 annual contribution limit will be indexed to the Consumer Price Index or CPI, in $500 increments, in order to account for inflation.

This measure was well received by Canadians, with the C.D. Howe Institute saying, “This tax policy gem is very good news for Canadians, and Mr. Flaherty and his government deserve credit for a novel program.” It also earned praise from the Canadian Federation of Independent Business, Canadian Bankers Association, Bank of Montreal economist Doug Porter, the Canadian Chamber of Commerce, Canadian Taxpayers Federation and numerous other organizations.

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