Tax-Free Savings Account... Good?

[FanIn80]

http://www.tdcanadatrust.com/tfsa/

Stolen from TD's site:

Starting January 2, 2009, there’s a great new way for you to save money. TD Canada Trust will be offering the new Tax–Free Savings Account, which was recently announced by the Canadian government in the 2008 budget. A Tax–Free Savings Account (TFSA) is a flexible investment account that allows you to earn investment income without paying taxes and gives you access to your money whenever you want it.

A TFSA is a great way to save money for major purchases like a car, a home renovation or a family vacation, to put away more money for retirement, or just to have money available when you need it.

Since I am relatively brain-dead when it comes to financial stuffs... what's the real verdict on this? It sounds really good, but there must be a catch or something I'm not seeing.

What's attracting me to it is the ability to set (and save for) short-term goals, without being kicked in the nuts when it's time to use the money for what I saved it for. Since I'm pretty accustomed to getting kicked in the nuts whenever I try to get between a bank and my money, I'm thinking that there's probably going to be some kind of delayed nut-kicking on this one... something that I might not feel until the end of the new year, for instance.

Anyone have any advice or thoughts on this new account?

[Ronald Pagan]

The only thing 'tax-free' about these accounts is the interest earned on them.

You still have to contribute to them from your net income.

[Jason14h]

If you have a savings account, it should be a tax free one going forward! Why would you want to pay tax on your interest!

[BerubeHater]

You can trade stock in the TFSA, and there are no capital gains.

[MoneyGuy]

Originally Posted by Ronald Pagan

The only thing 'tax-free' about these accounts is the interest earned on them.

You still have to contribute to them from your net income.

If you think they're not worthy, I disagree totally. I write a financial column in a couple of newspapers. Here is one I've done.

A perfect new piggybank

When the much anticipated tax-free savings account (TFSA) hits the streets on Jan. 2, 2009, you’d be wise to open one straight away. Probably the best new investment vehicle since the launch of the RRSP in 1957, it has exciting planning opportunities.

Sadly, we’ve fallen out of the savings habit. However, the TFSA, which allows you to save for retirement or any other purpose on a completely tax-free basis, should rejuvenate Canadians’ savings efforts. The TFSA may over time match the impact of the RRSP. In other words, it`ll be huge.

Every Canadian 18 years of age or older will be able to contribute up to $5,000 per year to a TFSA; this amount is indexed annually. Unlike an RRSP, you get no tax deduction for your contribution. However, unlike RRSP withdrawals which are fully taxable at your marginal tax rate, you never pay any taxes on TFSA growth or withdrawals.

Unused TFSA contribution room can be carried forward indefinitely. Any amounts withdrawn are added back into your contribution room. This is an advantage over RRSPs, where withdrawals are forever and those monies can never be replaced.

The TFSA is incredibly flexible, making it attractive for anything from short-term savings to saving for retirement. If you pay taxes and have savings of any kind, you might consider flipping those savings into a TFSA.

Understand this about a TFSA: It’s not a product. It’s a means of sheltering various products from taxes. You can put guaranteed investment certificates, term deposits, stocks, bonds, mutual funds, segregated funds and cash savings into a TFSA.

So, how should you use the TFSA? First of all, this does not replace an RRSP. We’re falling behind in our retirement savings, and – for most of us – the registered retirement savings plan is the best way to amass the money you’ll need for a comfortable, worry-free retirement.

Which is best, contributing to an RRSP or to a TFSA? It depends. I think that the best use of the TFSA is for folks who have maxed out their RRSPs and want to set aside more tax advantaged money for retirement. However, few people max out their RRSPs, so the rest must decide between the two choices. The higher your income, the more RRSP contributions make sense.

When income is less than roughly $37,000, you probably shouldn’t be making RRSP contributions anyway, so here the TFSA wins. Unlike RRSP withdrawals, TFSA withdrawals don’t count as income so won’t affect income-based payments such as Old Age Security and the Guaranteed Income Supplement. Also, RRSP withdrawals, unlike TFSA withdrawals, might push you into a higher tax bracket in retirement.

This is a complex choice that requires more space than I have here. Speak with your financial planner.

One of the best uses of a TFSA is for high-risk, high-return investments. If you hit that home run, those big gains are tax sheltered. Unfortunately, if you have a capital loss, you can`t use it to reduce capital gains.

A TFSA is also great for short- and medium-term savings. If you’re saving for a new car, vacation, house or a child’s university education, the TFSA is a perfect vehicle. Don’t bother with conventional bank savings at low, fully taxable interest rates for short-term money; high-interest savings accounts currently pay about three per cent. For medium-term savings where you can take more risk, a bond fund might be a good choice. For long-term objectives, look at a stock fund.

Here is an example of how a TFSA can really shine. Let’s assume that you have $25,000 growing at four per cent in a non-registered account. Depending on your tax bracket, you may be losing $350, or more, of that every year in taxes. Remember that it`s much better when money compounds in your pocket instead of being sent to Ottawa. As you add to your TFSA over years and as it grows and grows, you keep every penny.

TFSAs provide wonderful income-splitting opportunities. You can give a non-working spouse the money for a contribution and the income doesn`t attribute back to you.

If you’re not excited quite yet about the huge opportunities within a tax-free savings account, get excited. The financial community is ecstatic because we see the potential; count on hearing from your financial planner soon.

If you have after-tax income that's getting any return, there is no reason not to put it into a TFSA. None!

[czure32]

the TFSAs are going to be fantastic moving forward
IMO everyone should open one, especially if you have non registered money invested in GICs or just sitting in a high interest savings account

of note, the contribution room carries forward, and any amount that you take out you will get back in contribution room as well. So it can work out great as a short term liquid vehicle and even better for long term plans

[Ronald Pagan]

I'm not saying they're a bad thing. I've already registered for one. Just clarifying that you can't contribute to it to get tax credits from your gross.

It's tax free on the earnings.

[Patrick]

Originally Posted by fotze

I think it will be good for my kids college savings account, if you can put $5k in it per year that $90k at the end of 18 years will have generated hopefully a lot of tax free growth.

I would not do that. Do the RESP and make the gov match.

[BlackEleven]

It probably doesn't matter so much now, since its almost the end of the year but ING allows you to open an tfsa now. Since its not tax-free until 2009, they pay you double interest until then to cover the taxes, then transfer the amount (up to 5K of course) to a real tfsa on Jan 1. Pretty nice deal.

[MoneyGuy]

Originally Posted by Ronald Pagan

I'm not saying they're a bad thing. I've already registered for one. Just clarifying that you can't contribute to it to get tax credits from your gross.

It's tax free on the earnings.

Tis true. But every person who pays taxes and has investments or savings should open a TFSA.

[loob job]

Here are the general rules of thumb for the TFSA, I am an accountant:

If you have lower or same tax brackets in contribution years vs. withdrawal years you should invest first $5,000 in TFSA.
Contribute to RESP's to maximize Government contribution then contribute to childs TFSA once they turn 18.

If you are in the high tax bracket now and will be withdrawing them at the lower tax bracket when retiring then TFSA is not the way to go RRSP is the way to go. See example: Assumptions:

-Contributions @ 46% and withdrawls @ 33% tax rate
-$5,000 contribution made in year 1
- RRSP tax savings are used to purchase additional RRSP's for the first 3 years
- Contributions and withdrawals at beginning of year
- Annual return of 5% with full withdrawl in Year 11

RRSP Results
Total Contributions $8,845
Total Earnings $5,310
Tax paid on W/D $4,671
Cash after Withdrawl $9,484

TFSA Results
Total Contributions $5,000
Total Earnings $3,144
Tax paid on W/D $0
Cash after Withdrawal $8,144

As you can see if you are in this situation RRSP's are the way to go (if in high tax bracket now and will be withdrawing at lower bracket.
Hope this helps people.

[FanIn80]

Cool. I never realized how excited people were about this. Pretty much confirms this isn't just some gimmicky way of getting me to pay more taxes.

I just phoned TD and pre-registered for one. They're going to cal me on the 2nd and get me rolling.

Thanks for the responses!

[loob job]

Originally Posted by fotze

So loob job, you are saying that RRSP is still the preferred place, but if that is maxed out, then this is the next place for the cash to go followed by just regular investments?

Yes, assuming you are in the high tax bracket and won't be withdrawing until you retire.

The benefit of the TFSA is that you can pull it out at any time with no tax implication, but the negative is that may be to much temptation for people and they won't end up saving for the future.

[the lemming]

A few years ago I moved to a new job that has a defined benefit plan, so I have finally been able to get my RRSP contributions maxed out.

I have been negligent on getting started on the RESP's for the kids and this was going to be my next focus. Is the RESP still the way to go or is this new TFSA a better option?

I suppose I could put some into the RESP and some into a TFSA to save for the new roof/windows/landscaping... I think I need to get a second job.

[czure32]

Originally Posted by the lemming

I have been negligent on getting started on the RESP's for the kids and this was going to be my next focus. Is the RESP still the way to go or is this new TFSA a better option?

I would say the RESP is going to be better simply because of the government grants that you can apply for

if you contribute $2500/year the federal government will kick in a minimum of $500 (CESG - canadian education savings grant - this can potentially be higher based on your income situation) up to a life time maximum of $7200
children are eligble to recieve the CESG up to the age of 17
also children born in alberta in 2005 and beyond are eligble for a $500 ACES grant from the government of alberta. As well all children in alberta are eligible for an additional $100 at ages 8, 11, and 14

RESPs do cap though at lifetime contributions of $50k

[MoneyGuy]

I agree that unless your income is fairly low (generally, under $37K = lower tax bracket), the RRSP is the better option. The more your income, the more the advantage swings to the RRSP. However, there is much more to it than that, because you have to consider expected retirement incomes, retirement income needs and a lot more.

[czure32]

Originally Posted by fotze

I meant in addition to the RESP max of $2000/yr.

maximum RESP contributions per year restrictions have actually been lifted
its just a life time contribution cap of 50k, but the government will still only match a percentage of the first $2500

[Nancy]

Originally Posted by MoneyGuy

I agree that unless your income is fairly low (generally, under $37K = lower tax bracket), the RRSP is the better option. The more your income, the more the advantage swings to the RRSP. However, there is much more to it than that, because you have to consider expected retirement incomes, retirement income needs and a lot more.

Do withdrawals from RRSP's affect one's OAS eligibility? Would this be another benefit of the TFSA for very low income earners? (Versus the RRSP.)

[Patrick]

Originally Posted by fotze

So loob job, you are saying that RRSP is still the preferred place, but if that is maxed out, then this is the next place for the cash to go followed by just regular investments?

I would say it depends on your marginal tax rate. If you have a high tax rate I would do RRSP and get the deductions.

[Patrick]

Originally Posted by Nancy

Do withdrawals from RRSP's affect one's OAS eligibility? Would this be another benefit of the TFSA for very low income earners? (Versus the RRSP.)

Yes, you can get clawback if your RRSP withdrawal is too high.