Last updated: February 27 2008

Budget 2008:  Lots Of New Strategies For Income Splitting And Retirement Income Planning

The February 26, 2008 federal budget was short on the multiplicity of targeted tax fixes we have seen in previous budgets by this government, but contained one significant provision that will assist those in the throws of retirement income planning in particular, and families seeking new income splitting opportunities.

Tax-Free Savings Account

The new Tax Free Savings Account (TFSA) is an investment vehicle, unfortunately not available until 2009, that will allow Canadians over 18 to accumulate savings room of $5000 a year throughout their lifetime, and so with a life expectancy of approximately 80 years for the average Canadian, that means a funding potential of $310,000 over an average adult life span of 62 years.

Contributions to the account are not deductible, but earning accumulate on a tax free basis including interest, dividends and capital gains and withdrawals of both earnings and principle are tax exempt. However, those withdrawals will make new TFSA contribution room, on an indefinite carry forward basis, which provides us with some interesting new savings strategies for virtually every family member.

Moreover those withdrawals will not affect income-tested tax preferences like Child Tax Benefits, Employment Insurance Benefits or Old Age Security pension. This means you can earn the tax free investment income in the plan and avoid clawbacks, too. So how can Canadians take advantage of the plan? Several strategies come to mind:

  1. Family Income Splitting. There is no attribution rule attached to the new TFSA resulting income is tax exempt. So this is a great opportunity for parents and grandparents to transfer $5000 per year to each adult child in the family for the rest of their lives. Recipients can take the money out for what ever purpose they wish and create new TFSA contribution room; which means they can put it back to grow when the withdrawal need is met and new savings are achieved. This will be welcome news to grandparents in particular.
  2. Leveraging Tax Preferences: Consider funding this new bucket of savings' with your RRSP tax savings a great way to leverage two available tax provisions. But also look at your new investment options from the tax-exempt income within the TFSA. For example, it may make some sense to look at the tax-free income in the TFSA as a source for funding assets that will multiple on a tax exempt basis: for example life insurance, critical illness insurance or a tax exempt principle residence.
  3. TFSA or HBP? In the market to buy a new home. Consider whether it makes more sense to withdraw funds on a tax free basis from within an RRSP to fund a new home purchase under the Home buyers Plan or should the taxpayer save and withdraw funds under the TFSA instead? Certainly there are no tax penalties for failure to pay back the funds to the TFSA, and withdrawals automatically create new TFSA contribution room, so our vote would be to accumulate money in this new savings vehicle instead.
  4. TFSA or LLP? Education savings strategies should now be revisited as well for similar reasons as outlined in the last point. Saving within the TFSA allows you to accumulate funds on a tax-deferred basis and then withdraw them without penalty or a requirement to repay the funds. This is not so under the Lifelong Learning Plan, which allows for a tax-free withdrawal from the RRSP but requires an annual repayment schedule. The avoidance of income inclusion penalties therefore makes the TFSA a more attractive withdrawal vehicle for these purposes than the Lifelong Learning Plan. Better to leave the funds in the RRSP for tax deferred retirement savings.
  5. TFSA or RESP? This new account would also appear to be a better savings vehicle for education purposes than the RESP, which eventually could provide a tax penalty on withdrawal if intended recipients do not end up going to school. However, in making this choice the investor misses out on the Canada Education Savings Plan sweetener.
  6. Offsetting Pension Contribution Limitations. Contributors to employer pension plans are often precluded from making RRSP contributions because of their pension adjustment amount. Likewise those who have contributed the maximum to an RRSP 18% of earned income to $20,000 in 2008 and want to do more to supplement their savings on a tax-assisted basis now have the opportunity to tap into another tax deferred savings opportunity. In particular the TFSA a good place to park interest-bearing investments.
  7. Supplementing Executive Pension Funding: Executives who earn more than $111,111 in 2007 will be unable to save for retirement on a tax assisted basis for income above this amount. The TFSA provides a small window of opportunity to shore that tax assistance up. This option should be employed in conjunction with planning for funding of top hat plans like Individual Pension Plans or Retirement Compensation Arrangements.
  8. New Tax Sheltering Opportunities for more Pre-Retirees: The TFSA is a great savings option for people who do not have the required earned income for RRSP contribution purposes and therefore have few opportunities for tax sheltered retirement savings. This includes those in receipt of inactive income sources like pension income, investment income or employment insurance benefits.
  9. New Tax Sheltering Opportunities for RRSP Age-Ineligible Taxpayers: The tax shelter can continue for those who reach age 71 and don't need the money in their RRSP. While withdrawals must be generated under the usual rules, reinvestment into a TFSA will allow those tax-paid funds to grow again faster in a tax sheltered account, as opposed to a non-registered account.
  10. Benefits for Single Seniors: RRSP Melt Down Strategy Enhancements: It has always made some sense to melt down RRSPs to top income up to bracket in circumstances where taxes will be higher at death than during life. We generally use that strategy for singles or widow(er)s for example. Now surplus funds can be deposited into the TFSA so that retirees can continue to build wealth on a tax deferred basis and keep legacies intact.
  11. TFSA Borrowing and Excess Contribution Penalties: Because income from the TFSA is not taxable, borrowing funds to contribute to a TFSA will not be tax deductible. Using borrowed money to invest in non-registered accounts makes more sense as interest is then tax deductible. Also be aware that the new provision will result in a penalty of 1% per month if excess contributions are made to the account. Therefore it pays to look carefully at your Notice of Assessment from CRA.
  12. Estate Planning Considerations. Also note that the TFSA loses its tax-exempt status after the death of the plan holder, meaning that the investment income will become taxable, however a rollover opportunity is possible when the spouse or common-law partner becomes the successor account holder. This will not be affected by the spouse's contribution room and will not reduce existing room either. However, when a child dies without a spouse, the plan should be collapsed or transferred to another appropriate savings vehicle.
  13. Marriage Breakdown: Investors in the TFSA will be able to transfer from one party to the split to the other on a no-penalty basis, however, the transfer in this case will not re-instate contribution room for the transferor. Nor will it affect the contribution room of the transferee.
  14. File a Tax Return: yet another reason to endear oneself to the tax system: a return is required to build TFSA contribution room and so it is folly to file late or miss filing a return. Remember there is a statute of limitations of ten years in filing late or adjusted returns. Don't cut into your tax exempt wealth accumulation potential by being tardy on this front.
  15. Investment Ordering Decisions. The New TFSA requires a second look at the order in which investors maximize accumulation activities. Taxable investors should consider family priorities and then contribute funds in this order:
    1. To an RPP
    2. To an RRSP (including spousal RRSP)
    3. To a the TFSA
    4. To RESPs (Registered Education Savings accounts to maximize Canada Education Savings Grants and Bonds)
    5. To RDSPs (Registered Disability Savings Plans to maximize Canada Disability Savings Grants and bonds.)
    6. To non-registered accounts


  1. RESP contribution, withdrawal and savings periods have been extended
  2. Northern Residents Basic Residency Deduction increases to $8.25 and $16.50 per day.
  3. Medical Expenses: There are four new prescribed expenditures, including the acquisition, cost, care, training and maintenance of service animals who assist people with autism or epilepsy.
  4. The capital gains exemption on donations of publicly traded securities to public charities and private donations will be extended to gains realized on the exchange of unlisted securities that are shares or partnership interests for publicly traded securities.
  5. Dividend tax credit and gross up rates will drop effective 2010.
  6. CCA accelerated rates have been extended in manufacturing and processing and clean energy generation
  7. The Scientific Research and Experimental Development Program has been enhanced.
  8. Businesses who make source remittances late will get a break on penalities in the first late week.

Details of individual provisions follow.

Next Time: Taxes Just Keep Rising for Pre-Retiring Baby Boomers and their Heirs. The federal budget predicts that personal tax revenues ñ by far the largest revenue line item for the government ñ will increase by $2 Billion in 2007-2008 and thereafter increase faster than personal income growth to $125,475 Billion in 2009-2010.