Tax-Free Savings Accounts. TFSAs, or “Tiffsas,” if you will. For the last year, we’ve been bombarded with information and advertisements from the banks through politicians, to your next-door neighbour - and, obviously, your advisor - asking if you’ve made YOUR contribution. At this point, one might get the impression that RRSPs have been put out to pasture.
I’m not totally convinced. I get the impression that, like many RRSPs, TFSAs are going to be used as cash-storage vehicles, and that misses the entire point.
Let’s start off with the fact that, until 2012, we’re only limited to a $5000 annual contribution (For 2-parent family, with children under 18, that’s $10,000 in possible household contributions - one spouse can contribute on behalf of the other, without worrying about tax implications). RRSPs, on the other hand, will typically allow for a larger contribution ($21,000 maximum contribution for the 2009 tax year), as well as generate a tax deduction for every dollar contributed. Dollar-for-dollar, the RRSP may be the better choice.
I’ve been asked whether it makes more sense to max out the RRSP contributions, or hold off to make TFSA contributions instead. My opinion on the matter - contribute as much as possible to the RRSPs first, before putting money into the TFSA. The tax deduction for the RRSP is more than worth it, especially if one’s income lands in a high tax bracket. Keep in mind that the $5000 TFSA contribution limit doesn’t just evaporate if the whole amount isn’t used immediately. If, say, $2500 is all one can manage for this year, the remaining $2500 will roll over; $7500 will be next year’s maximum contribution. And so on and so forth.
Additionally, I’m not a fan of holding cash and GICs in the TFSA. The most efficient use of the program, in my opinion, is long-term investing. Cash is primarily a short-term vehicle, and GICs should be, as well. To set aside money for building a new patio, or taking a Mediterranean vacation next year, one might be better off just using a regular savings/GIC account. On the other hand, if the idea is to build a retirement nest egg, and not be brutalized by the Canada Revenue Agency (CRA) when money is withdrawn during the golden years, a mix of cash, bonds, and high-quality equity holdings can be the better option.
Example - let’s say I were to find a decent fund, or set of stocks. But the underlying companies - blue chip companies who pay dividends - were based in Europe. From the CRA’s perspective, the dividends paid to me by those companies are fully taxable (Those companies are corporately taxed in their native countries, not Canada, and thus the full wrath of the CRA now falls upon my head - foreign tax credit notwithstanding). In their eyes, if I hold those investments in an open account, I may as well have gotten a part time job and received more income. On the other hand, if I were to hold my shares in a TFSA, the benefits are twofold:
1) The dividends can be reinvested into those companies, to purchase more shares, and
2) I won’t pay any tax on the dividends. Or the growth in the value of my holdings. Ever.
Now, keep in mind that if you purchase TFSAs, all of the holdings need to fit into the total investment plan. That includes your RRSPs, open investment accounts, and any other types of accounts/investments you might hold. If your investment policy statement (IPS) - the blueprint for your financial holdings - tells you to allocate only 5% of all your capital to, say, global science and technology, and your TFSA investment has bumped your allocation to 10%, you may want to think this through some more.
As with any investment, one could be looking at years or even decades, before the value of the TFSA account has potential to turn into a worthwhile retirement income vehicle. In the mean time, the possibility exists that the Federal government may freeze the contribution amounts. Or even scrap the program altogether - Ottawa is practically handing money away by not taxing the growth happening in these accounts.
As always, it pays to get as educated as possible on these programs. Visit the CRA website for more info on the TFSA, and check sites like Globeinvestor, Million Dollar Journey, and and Canadian Capitalist to brush up on your financial IQ. Good luck!
