TFSA: Making the case for a Real savings account

TFSA

Making the case for a Real savings account…

by Michael Manirakiza, Member of the Arbitrage Magazine Board of Directors

So you dream of that trip to Nicaragua next spring after this cold winter. Based on your part-time job, you might be able scrounge together $1000 bucks (more or less) and steal your dad’s credit card on your departure day. Great plan, now let’s see how it turns out!

Maybe you’ve heard about a new account that can help you save and earn interest on your money … tax-free. Let’s repeat that together, TAX FREE!

Back to our student who’s thinking of putting away $1000 bucks for a trip with friends. He likely doesn’t care about interest or a return on investment (ROI), because he knows that its coming from his paycheck and going straight under his bed or in a regular savings account. But we know that the former won’t make him any money while he saves and the latter will give him a petty interest of 0.05% according to the average savings rate. That translates in more or less 5$ for the year, clearly better than the mattress but our friend can definitely do a lot better.

Image by Jeff Fritz

The Tax-Free Savings was rolled out by the Federal Canadian Government in January 2009, and it functions exactly like a savings account with a few exceptions. I believe every student in school over the age of 18 years old should open one on their next trip to the bank or at least get educated on it. If your out of school its not too late.

Why you ask?

Well for several reasons that will give you food for thought.

In a TFSA, you’re allowed to save up to a maximum of $5000 a year and not pay taxes on ANY money you earn in the account, FOREVER. The following year the government allows you to put in another $5000. This goes on year after year, and if you withdrawal any amount, you don’t lose the savings room you’ve build. For any post-secondary student, or young adult for that matter, this can get you some honest return on your money than that regular savings account the bank doesn’t pay you enough to keep your money in!

If you shop around, soon enough you’ve find out that you can earn upt to 2% in a TFSA without locking your money (meaning accessibility anytime) and, best of all, that’s tax-free!! Doing the math (1000*2%=$20), our friend can buy himself breakfast at least twice or get a few nice souvenirs from his trip! Now that’s a savings account.

But wait! There’s more!

If you’re financially savvy, things can get interesting! (If not, I recommend getting a friend who is or seek advice from a qualified profession.) Your TFSA can hold different types of products, besides being a regular savings account; you can hold  mutual funds, GICs and stocks.

[pullquote]Here is the true power unleashed by this little account that can pack a punch. Add to your savings and keep the taxman at bay![/pullquote]

A good balanced mutual fund can earn you a 3% to 9% return after fees (gross return – fees = your return). If held in a TFSA, that’s all tax-free! Now our friend is making some real bucks.

But beware mutual funds are for long-term investors, not recommended for short-term projects, such as a trip to Nicaragua. Also, the mutual fund may be invested in the stock market, which means fluctuation in the value of your savings (that said, losses can not be written off when doing your taxes).

The other awesome product that’s allowed in the fund are stocks. To simplify things, I will touch on the main points. If someone told you that major financial institutions in Canada doubled in their stock price (between march 2009 and September 2009) and they had a cut of the action, your jaw might drop! In English, your ‘friend’  could have bought shares through an online brokerage account and held some shares through his stock TFSA, earning a 100% return on his money Tax-free!

This outcome could have just been a good call on your friend’s part, or your friend may have good analytical abilities and of course, financial knowledge. The interesting fact here is how much he got to keep, assuming he had $500 in stocks in his TFSA, than he made $500 and didn’t have to pay taxes. Here is the true power unleashed by this little account that can pack a punch. Add to your savings and keep the taxman at bay!

If our friend gets a chance to meet someone where he usually banks, assuming I’m the advisor there,  we would sit down to determine what his short term, medium projects are and find out if he has a TFSA already. If not, than I would highly recommend it for those projects, since it’s the best financial product with a net benefit to the consumer, rather than the institution providing it! There are some rules on TFSA stock account I’ve skipped for the sake of simplicity but you should get more information from your financial institution.

Happy New Year to all Arbitrage Readers! Open your TFSA Today!

ARB Team
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