Tax Free Savings Account Info For Canadians
So I’ve completed some of my Tax Free Savings Account (TFSA) homework and already I’m impressed. If you don’t already have one set up, hopefully by the time you finish reading you will understand you need to get an account established. Just to warn you, if you haven’t already set one up, it’s not a race, you truly should do some of your own research first as there are many options. As always, some options are much better than others are.
To start with, many people are wondering exactly what is a TFSA and how does it work? When I started researching, I was expecting a very complicated answer to this question, but as it turns out, it’s surprisingly simple. It also has some very promising long term implications as a savings/investment tool.
A TFSA is a special savings account that can be opened by anyone who is a resident of Canada 18 years of age or older. This savings account has a current contribution limit of $5,000 per year and any growth in the principal is completely tax free. This $5,000 is indexed to inflation, but will never decline below $5,000, so over time you will be able to contribute more in some years and potentially this limit will increase each year.
The part that gets interesting is you can keep up the same types of investments in your TFSA that you would also be able to keep up in an RRSP. Traditionally this would be mutual funds, GIC’s, bonds and publicly traded securities. Many people are unaware that they can also keep up Arms Length mortgages, Mortgage Investment Corporations (MIC’s), or other real estate secured financial instruments in RRSP’s in addition which can also be held in a TFSA.
While mutual funds and securities can be quite volatile as everyone has seen with the stock market lately, GIC’s and bonds however are quite stable with their returns. The problems with GIC and bonds are there is so little risk that the returns are low single digit and after inflation you end up almost breaking already, which is not how you get ahead with an investment.
Opportunities like MIC’s and Arms Length mortgages however tend to be slightly riskier, but are attached to character which I consider very obtain, and tend to have fixed yearly returns of high single digit and low double digit. Coupling products like these with compounding interest inside a TFSA creates an opportunity for individuals to generate meaningful growth over time all tax free.
If you consider a associate each investing $5,000 per year in their TFSA and generating a 10% per year return after ten years the $100,000 invested by the associate would be worth $175,000 and is all tax free. Now if you compare this same situation to a $5000 yearly contribution to an RRSP, with the same yearly growth, you would also have the same amount of money at the end, but when you are forced to withdraw it from your RRSP, you would then be taxed on the complete amount!
I’m not positioning this as the end of RRSPs, but as a complementary tool to utilize if you currently have RRSP’s. Or if you don’t use RRSP’s to take advantage of the deduction, you can use the TFSA to save future taxes.
Some great options you have with the TFSA that really help seal the deal is the ability to withdraw from the account at any time and then re-contribute this withdrawn amount back in future years. This allows a younger person just starting out to potentially use the TFSA to save money for a down payment on a house tax free. Or a family could use it as an emergency fund that grows tax free.
Another alluring aspect is carrying over any unused contribution room. If you only have $1,000 to add to it next year, you could then add $9,000 in the following year. This will negate much of the value of compound growth, but will also allow you to contribute more in profitable years, and less in slower years, without being penalized.
Now as you are probably aware, every bank and trust company you can find in Canada seems to be offering to set you up with an account. The part you need to be aware of is that the majority of these institutions will only allow you to place these funds into the limited financial instruments like GIC’s, mutual funds and bonds that they offer. If your goal is to put a certain security fund or MIC into your TFSA, you better be sure you are allowed to do that by the institution you are working with.
Much like RRSP’s there are also some companies allowing you to set up self directed TFSA’s, but if you establish your account with one bank, you may incur additional costs transferring it over to another place. This will require you to have a plan prior to randomly starting the account at your closest bank.
I hope you can see some of the positive possibilities obtainable by setting up one of these accounts and I have managed to get you a bit excited about this. I’m currently looking into more information about some of the MIC’s as I think this may be one of the better options to get started with for people. They are have slightly more risk than a GIC, considerably less risk than most mutual funds, and provide a pretty stable return to grow your investment.
So I have now walked you by the basics of Tax Free Savings Accounts, I’m sure I have now opened a new topic with the option of MIC’s and many of you may be wondering how and where to get information on these. Well don’t worry I won’t leave you hanging with this either. I’m working on information on this in addition, so if you want to get updated on this make sure you leave me a comment, email me or give me a call.