Budget 2008: Shelter for Your Capital Gains

The TFSA accounts are similar to United States Roth IRA accounts and tax-free savings accounts in the United Kingdom that allow taxpayers to contribute after-tax income to tax-free savings accounts. In the U.S., Roth IRA accounts allow clients to contribute $5,000 every year. Those over 50 years of age are allowed to contribute $6,000 each year. In the UK, the annual contribution limit is 7,200 pounds.

The proposed savings accounts for Canadian taxpayers allow investment income and capital gains in the TFSA plan to accumulate tax-free — the funds are not subject to tax, even when clients withdraw the assets. Further, funds withdrawn from the accounts actually free up contribution room, allowing clients to replace the investment, spend gains and contribute again, all without affecting federal income tested benefits or credits like the Canada Child Tax Benefit, Goods and Services Tax Credit, Old Age Security Benefits, Guaranteed Income Supplement or Employment Insurance benefits.

“This will be especially helpful for people in their early 50s who, for whatever reason, have not done as much planning for retirement as they would like to have done,” says Peter Drake, chief economist at Fidelity Investments Canada. “For people who need to try and accelerate the rate at which they’re saving, this will give them some tax advantages. It’s not the barn-burner that RRSPs were when they first came out, but institutionally it is another place to put some money.”

If the budget is passed, Canadians over the age of 18 could save up to $5,000 every year, beginning in 2009. Contributions to a TFSA would not be deductible for income tax purposes. Unused contribution room could be carried forward to future years, spousal contributions would be allowed and TFSA assets could be transferred to a spouse upon death — surviving spouses would be able to roll the assets into their own savings accounts or hold both accounts separately. Although surviving spouses would not be allowed to make use of their deceased spouse’s unused contribution room, the rollover makes their own account larger, without reducing their own contribution room.

The new accounts offer a number of interesting planning opportunities for clients and financial advisors. For seniors over 71 who can’t contribute to their RRSP, “this is an alternative to create tax deferred investment income,” says Dave Clarke, senior manager, Collins Barrow Ottawa, LLP. “A lot of seniors living off their investments will be able to contribute to this account, earn tax free income and withdraw to pay their living expenses. That income would be taxed outside of this plan.”

Those planning to make use of the Home Buyer’s Plan (HBP) to purchase a house can also invest in the accounts to build a larger down payment, more quickly once their RRSP balances exceed the $20,000 withdrawal limit allowed under the HBP.

“And obviously, it’s great for people who’ve maxed out their RRSPs and are looking for other ways to shelter investment income,” says Clarke.

When planning for those who haven’t yet maxed out their RRSPs, however, Clarke says RRSP contributions still make more sense — “more bang for your buck” — unless clients are saving for something specific, simply because clients defer initial income taxes. “Where people will need guidance is in defining their savings objectives, and then choosing the best vehicle to help them get there.”

On the advice front, it also pays to remind clients to be wary of their contribution room limits — excess contributions would be subject to a tax of 1% each month.

Clients who become non-residents of the country would be allowed to maintain their TFSA holdings, with tax exempt benefits, but no contributions would be permitted while the individual is non-resident. Budget documents do not suggest the government has any plans to allow in-kind share transfers at this stage.

The accounts would generally be permitted to hold the same investments allowed in a Registered Retirement Savings Plan, including mutual funds, public securities, government or corporate bonds, guaranteed investment certificates and, in certain cases, shares of small business corporations. TFSAs would not be able to hold investments in any entities with which the account holder does not deal at arm’s length. For this purpose, specified shareholders, generally those with a 10% or greater interest in the company or investment in question, either personally or as part of a group, are not able to hold that investment in a tax-free account.

Other measures

In addition to the Tax-Free Savings Accounts, several other measures were tabled in this year’s federal budget for business owners, students, seniors and clients with certain medical expenses.

Seniors: In addition to past changes that doubled the pension income amount to $2,000, increased the Age Credit amount by $1,000, increased the age limit for maturing RPPs and RRSPs from 69 to 71 and allowed pension income splitting for seniors and pensioners, the proposed budget would increase the amount that seniors could earn — from the current maximum exemption level of $500 to $3,500 &/151; before their Guaranteed Income Supplement was clawed back.

Medical expenses: According to government documents, the list of eligible expenses under the Medical Expense Tax Credit is reviewed regularly and updated in light of new technologies and other disability-specific or medically related developments. This year, the budget proposes to add altered auditory feedback devices for speech disorder treatment, electrotherapy devices for the treatment of medical conditions or severe mobility impairment, standing devices to help severe mobility impairment and pressure pulse therapy devices for the treatment of balance disorders. The budget also proposes to extend eligibility and recognize expenses for service animals trained to assist those affected by autism or epilepsy. Currently, only expenses for service animals trained to assist deaf or blind patients are recognized.

Students: The children of those contributing to Registered Education Savings Plans could have an additional 10 years to make use of the accumulated assets — proposed changes increase the amount of time an RESP may remain open from 25 years to 35 years. The proposal also extends the maximum contribution period by 10 years. Changes to plan termination limits and the maximum contribution period would apply to all existing and future RESPs, effective January 1, 2008.

As the Canadian Millennium Scholarship Foundation winds down, the government also plans to invest in a consolidated Canada Student Grant Program, aimed at reaching 245,000 college and undergraduate students each year, beginning in the fall of 2009. It also plans to provide $25 million over two years to establish a new graduate scholarship award for top Canadian and international doctoral students, plus $3 million over two years to establish a new international study stipend for the graduate scholarship recipients who wish to study at international institutions. The budget also proposes to streamline the Canada Student Loans Program.

Business owners: For businesses in the manufacturing or processing sectors, the budget proposes to implement three years of accelerated capital cost allowance (CCA) treatment that will allow business owners purchasing manufacturing and processing equipment between 2009 and 2011 to write off that equipment at an accelerated rate over the three year period.

The budget also proposes to reduce the record-keeping requirements for automobile expense deductions.

Non-residents: Those buying Canadian property from non-residents, non-residents trying to sell their Canadian property, and those who are exempt from paying Canadian income taxes under international tax treaties could benefit from streamlined cross-border tax-withholding and return filing rules.

For more federal budget coverage, click here to read our special online section, Budget 2008: Special Report.

Filed by Kate McCaffery, Advisor.ca, kate.mccaffery@rci.rogers.com.