Budget 2008
The 2008 Federal Budget contains a number of important initiatives that will be of particular interest to Canadian investors. These include: New tax-advantaged ways to save – Beginning in 2009, Canadians can contribute up to $5,000 per year of after-tax income to a new Tax-Free Savings Account (TFSA). Investment income and capital gains earned within the account will not be taxed and withdrawals will be tax-free.
Increased flexibility for locked-in retirement savings – Eligible Canadians 55 years and older are now entitled to unlock up to 50 per cent of their Life Income Fund (LIF) holdings into a tax-deferred savings vehicle with no withdrawal limits. As well, individuals aged 55 or older with holdings of up to $22,450 will be able to wind up their accounts with the option to convert to a tax-deferred savings vehicle.
Encouraging higher learning – Families now have more years to contribute to their children’s Registered Education Savings Plans (RESPs). The contribution period and the deadline to plan termination have been extended by 10 years to 31 and 35 years, respectively. (Note the maximum lifetime contribution limit of $50,000 has not been raised).
New ways to give – Canadians can now receive a capital gains exemption for donating unlisted securities to registered charities when they are first exchanged for publicly-traded securities. This is an extension of the existing capital gains tax exemption for donations of publicly traded securities.
Spotlight on Tax-Free Savings Accounts (TFSAs)
The introduction of TFSAs represents a huge new opportunity for Canadian investors. In effect, TFSAs are the mirror image of Registered Retirement Savings Plans (RRSPs).
While TSFAs are described in the budget documents as being helpful to people saving at any age, they will be especially helpful to people saving for retirement. For younger people, the prospect of tax-free investment returns over a period of 20 or 30 years is enticing. For people in their early 50s who need to step up their saving for retirement, TSFAs represent an additional source of significant tax savings that can remain open long after an RRSP has been collapsed. From a retirement income point of view, withdrawals from TFSAs should have a higher tax priority than withdrawals from unregistered assets, with the very important added advantage that the investment earnings inside the plan are tax-free.
Highlights:
Contributions can be made from after-tax income to a maximum of $5000 annually, and this will be indexed to inflation in $500 increments. On a practical note, eligible investments for these plans will be basically the same as for RRSPs, and any institution that can now open an RRSP will be able to open a tax-free savings plan in 2009.
The tax advantage of a TFSA is the absence of tax liability on any investment earnings inside the account. Nor is there any tax payable on withdrawals from the plan. This is an important contrast to RRSPs, where there is no tax liability on investment earnings within the plan, but total withdrawals (principal and investment earnings) are taxed immediately.
Since there are no tax consequences for withdrawals, there is no upper age limit when the plan must be collapsed (unlike an RRSP). This is a benefit for Canadians who work or are planning to continue working into retirement.
Unused contribution room in a TFSA can be carried forward, and a withdrawal creates contribution room equal to the amount withdrawn. Spousal TFSAs will be allowed. Neither income earned within a TFSA nor withdrawals from it will affect eligibility for federal income-tested benefits and credits.
Unlike income from a RRIF (or other equivalents), withdrawals from a TFSA will not be considered pension income, and will not be eligible for pension income splitting.
Similar types of accounts are in use around the globe and have become a preferred savings vehicle for many investors. The TFSA is similar to the Roth IRA in the U.S. and the Individual Savings Account (ISA) in the U.K. Both programs started with smaller maximum contribution rates, which have increased over time.