Tax Free Savings Accounts

Tax Free Savings Accounts

During the past few years I have seen a number of TFSA accounts, usually opened at banks and virtually all of them in some form of interest bearing account and usually in a term of 1-3 years. This is all well and fine, especially coming off the performance of the stock market during most of the 1st decade of the 21st century. Market performance was bad and so investors became nervous and wanted a safe haven in which to park money. They didn’t want to worry about the safety of their money, nor did they want to pay taxes on any gain, and they also wanted to have access to it in the event they needed it.

How they’re being sold:

  1. As a great place to invest some short term money
  2. Keep it safe
  3. Keep it accessible

Rules for TFSAs

  1. There is no tax benefit for purchasing them. You buy them
    with after tax money.
  2. There is no tax on any gain—ever—even when sold or when
    you die.
  3. Every Canadian citizen, aged 18 years of age and older as of
    2009 is permitted to invest up to $5,000/year since January 1,
  4. Whatever amount you don’t invest in a given year
    accumulates and you are permitted to make up in subsequent years i.e. the investment amounts accumulate. So, during 2012, if you have not ever invested in a TFSA, you are permitted to invest $20,000.
  5. If you withdraw money in a given year it is no problem(depending upon the type of investment you have purchased), unless you have purchased your maximum allotted amount i.e. $20,000 by 2012. If you have invested
    $20,000 by 2012 and withdraw any amount, you will not be
    able to replace it until 2013 or later.
  6. If you pass away, the entire proceeds(investment amount plus
    gain) go to your named beneficiary tax and probate free.
  7. You can invest in virtually any type of investments inside
    your TFSA, e.g. Savings Account, GIC, Mutual Funds, Segregated Funds, Stocks, and Bonds.

Are They Worth it?

  1. If you invest $5,000/year and earn 2% you earn $100 in the
    1st year. If you leave it untouched for 10 years it will amount to ~$1,500(compound interest). How much tax have you saved? Answer: $350-$400 over 10 years!! Not very much. It is hardly worth it!!
  2. But, if we change the scenario a little bit. If we can get a return in the 6% range, we will earn $300 in the 1st year. If left for 10 years at the same rate, the investment amounts to ~$9,000 or $4,000 of gain and ~$1,000 of taxes PERMANENTLY AVOIDED.
    Now, if you can add an additional $5,000 each year to this account and continue to average 6%/year, the numbers get even more  significant. By the end of the 10th year you have invested $50,000, gained ~$20,000 and PERMANENTLY AVOIDED ~$5,000 of taxes. If you are a married couple you can double this amount. If you are in the middle or higher tax bracket you can increase this again. For example, assume you are married and in the 44% bracket. You would have PERMANENTLY AVOIDED paying ~$17,500 of income taxes in only 10 years!
  3. In what order should we be spending our money? Answer: It depends on our situation. If you’re working and earning a significant income it makes sense to spend your TFSA, especially if it gained a lot last year and you need some funds to purchase something and you don’t have access to other non-registered funds that have minimal tax consequences if
    withdrawn. If you are retired, I suggest you should spend your RRSP at least to the top of the lowest tax bracket, then your non-registered funds, and then your TFSA in that order.
  4. Like I‘ve said to many of you in meetings during the past few years, if you could create your perfect investment scenario at your deathbed, you would have all your funds in a TFSA. If you had more than the allowable amount; the funds would be in non-registered accounts; and then the excess would be in RRSPs or RRIF accounts. Unfortunately most of us have most of our investable assets tied up in RRSPs because they were far more attractive to purchase during our working years. This is reality. RRSPs are still good investment vehicles.
  5. BOTTOM LINE: Use TFSAs wisely. They can do a lot over time if invested wisely and successfully. They are best utilized for longer term purposes but can also help for shorter term periods of time.
  6. BE CAREFUL– If you are using TFSAs for short term purposes such as emergency funding or for paying tax bills or the like. The Government monitors your deposits and withdrawals for TFSAs. Keep track of ALL of your deposits and withdrawals. In addition, the benefit of TFSAs, if invested only in Savings Account type of investments, will be miniscule.
  7. We sell TFSAs. I like them if used properly. I believe they should be used for longer term goals, i.e. at least 5 years. I believe one should be somewhat aggressive inside your TFSA but not extremely aggressive. The reason I suggest not to be extremely aggressive, e.g. penny stocks, is because penny stocks tend to be very volatile and losses occur almost as frequently as gains. If you lose money inside a TFSA you cannot write off the loss whereas you can outside the TFSA. In addition, if the stock becomes de-listed, and/or worthless, you cannot replace the lost funds inside your TFSA. So, for me there must be at least a reasonable opportunity to make money in order for me to utilize the investment inside my TFSA.
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