TFSA: Tax Free Savings Accounts

There has been a lot of misleading talk surrounding the new TFSA or Tax Free Savings Accounts.

They do NOT have to be Savings accounts.

The account itself is similar to an RSP in that you can hold savings accounts, GIC’s, Mutual Funds, Stocks, Bonds and a few other securities in the account. They also do NOT need to be opened at your bank (and really if you are reading this should have one with me )

Most institutions do not have any annual fee for these accounts and most do not have any transaction fees depending on the security that you hold within the account. You can have more than one TFSA (just like an RSP) however amounts are tracked so that you do not go over the maximum contribution limit (5K for 2009).

If you do go over this limit you will penalized by CRA in the tune of 1% per month for any money that you are over. In my opinion there is little advantage of having more than one since in one account you can hold any mix of the investments mentioned above.

How they work (or are taxed)

Anyone over the age of 18 that is a Canadian resident can open one. No “room” is needed to have one. Unlike an RSP you will NOT get a tax deduction for depositing to them, however, unlike an RSP you will NOT be taxed on any growth within the TFSA. This is where it gets fun. You can use these accounts for many applications. If you do not have an emergency reserve of cash, then this is a great place for it.

You can hold it in a savings account or GIC or Bond, and any interest that you make on that money will be tax free. This is important since interest income is taxed at the highest rate and in some circumstances even higher than earned income. Saving for a house? This is the place to do it as any interest or capitals gains made while saving will not be taxed when you take it to buy your house (or cottage, or car or whatever).

Another very neat and important difference between TFSA and RRSP is that any money you take out of it gets ADDED to your limit for the next year (more on this later). Another application for this account could be for your very aggressive or speculative investments. Let’s say you have an emergency account already, or line of credit that you would use in case of emergency.

Your need for liquid “safe” money is not high so you put 5K into a speculative security, that security hits and you triple your money in a short time. You take the 15K out and put it in your pocket TAX FREE. AND 15K gets added to next year’s TFSA amount. The downside of this is that if you lose any money in the speculative security you cannot claim capital losses either. (ask more about this is it is of interest).

As you can see they are a little bit more complicated in some ways but are also much more flexible and can be used for many different applications. In my opinion (and the opinion of my two close accountants) everyone should have one of these regardless of goal for the money deposited.

There is no downside.