The TFSA, or Tax Free Savings Account Canada, is here!

T he Tories have promised something for investors since they were elected. The biggest election promise that I was hoping for this year was the capital gains exemption that they spoke of a couple years back. The plan was that investors could carry forward their capital gains taxation provided that the money was reinvested within 6 months. We can all see the benefits of this type of taxation, but we can also see the immense amount of additional paperwork and cost required from the government.

You probably know by now that the new budget does not include the capital gains exemption. However, there is a big bright spot in the budget for investors, that is the introduction of the Tax Free Savings Account (TFSA). Im actually pretty excited about this account as it has MANY possibilities.

• Starting 2009, anyone aged 18 or older can contribute $5000/yr to the TFSA.
• The TFSA can grow and be withdrawn completely tax free .
• You never lose contribution room even when withdrawn.
• Withdrawals can be made at ANY TIME with no withholding tax .
• Contribution room can be carried forward indefinitely.
• You can contribute to a spousal TFSA, and they can withdraw from it tax free (income splitting).
• Withdrawal income does not affect government benefits like OAS, GIS, or CCTB .

The Fine Print:

• Contributions are not tax deductible.
• Capital losses cannot be claimed.

The Possiblities:

• The account can be used as a simple savings account where interest can grow tax free.
• This could be an opportunity for stock trading pros to utilize their options/shorting strategies without their gains being taxed as income.  Thus far (as of Jan 2, 2009), Questrade is the first discount brokerage to offer a tax free trading account.
• An opportunity for income splitting where couples now have double the TFSA room to play with.
• Invest in strong foreign dividend companies and withdraw the dividends TAX FREE. Right now, if you receive foreign dividends, they are taxed at your marginal rate. If you put these foreign dividends in an RRSP, they grow tax free, but you are taxed when you withdraw. The TFSA provides a great way to get exposure to those juicy American dividends, tax free at that.
• Invest in higher yield bond funds/income trusts and withdraw distributions as a tax free income supplement.
• Opportunity for non-registered portfolio rich seniors to move their dividend paying stocks into a TFSA to prevent OAS reduction .

How does this affect The Smith Manoeuvre strategy?

According to Jonathan Chevreau . the interest used to borrow for TFSA contributions are not tax deductible. Along with that, the contribution limits are restrictive for a full fledged leveraged account. These factors make the TFSA not ideal to use with The Smith Manoeuvre .