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TFSA (Tax Free Savings Accounts) Basics

young — Wed, 03 Feb 2010 04:48:58 +0000

Since everyone is likely busy finding money to fill their RRSP’s (the deadline is March 1, 2010 to claim for the 2009 tax year by the way), people probably aren’t focusing on the TFSA’s right now. If you are a 20something and are in school and aren’t making that much money (aka you’re not getting taxed to the nines), you should think about contributing to a TFSA instead.

The TFSA’s were introduced in the since January 1, 2009 and is basically the greatest thing since sliced bread (or RRSP’s which were introduced almost half a century ago- before we were even born, shucks!)

Like RRSP’s, TFSA’s are not an investment per se, think of it like a glass jar. It’s a container where you put your investments. Anything that you EARN from putting stuff in this container is withdrawn tax free.

The TFSA is basically the inverse of the RRSP (DANG, Jim Flaherty- you’re not just a pretty face after all!)

In the TFSA you invest with your after-tax hard-earned bloodsweat money, and money that is withdrawn from it is NOT taxed.
In the RRSP, you invest with pre-tax dollars (yes, the tax refund is supposed to reflect this) and money that is withdrawn is taxed– the caveat is that most people who retire are at a lower tax bracket so they will pay less tax on the money withdrawn.

You can hold many things in the TFSA (except USD holdings- only Questrade TFTA’s allow this) and it’s the same for an RRSP.

TFSA Rules:

You have to be over 18
Everyone gets $5000 a year max to contribute
Any unused space in your $5000 can be carried forward to next years (e.g. you only contributed $2000 in 2009, you can contribute $7000 in 2010)
TFSA’s don’t expire (so you can be 98 and still have a TFSA- whereas you HAVE to start withdrawing RRSPs at 71)
TFSA’s can hold anything that RRSP’s can hold (For some reason, I have the song “I Can Do Anything You Can Do Better” in my head)

What should you put in your TFSA?

90% of people who start up a TFSA end up stashing their cash in a fixed income high interest savings account that earns 3% (max…) ING Direct is offering this right now, but doesn’t guarantee how long the 3% will last. Let me give you a hint…Not long. But at least with the orange key, you get the 3% for an undefined amount of time, AND $25. One other bonus is that ING Direct won’t charge you fees.

That’s good if you want to use it as an emergency cash savings “jar”. But it’s not recommended. After one year at 3% you’ll only get $150 (x your marginal rate of 40%….which is… wait for it……. $60 saved in taxes). So you should definitely let your friend, compound interest take over.

If you’re looking for more growth, then the self directed TFSA is probably the way to go.

You can hold mutual funds, ETF’s, bonds, stocks.. you name it in your TFSA investment account.

Some TFSA Investment Account brokerages/ banks:

Questrade No fees; check out my post on Tax Free Trading Accounts here
Scotia itrade No fees.
HSBC
CIBC
BMO
TD Canada Trust
RBC

Just a word of caution- some of the bigger banks have fees associated with the registered TFSA account (just like how I have to pay BMO Investorline $105 a year for having an RRSP account open with them- which they neglected to tell me about when I signed on, but that’s another story).

OR you could open up a TD E-Series mutual fund account (low MER’s yeeehaw AND no fees) and put in a small amount each month (e.g. $400) for dollar cost averaging.
I have TD E-trade RRSP account and love it- but it was quite arduous to get it in the first place!
I would recommend going to a TD Branch first and getting a basic mutual fund account (don’t buy any mutual funds on it though!), then convert it to the E-trade account by calling in and then buy your mutual funds there.

Hope that clears up some of the confusion surrounding TFSA’s!
What have you filled with your TFSA?
Any suggestions?

RRSP Part two: what to keep outside of that RRSP

young — Thu, 10 Dec 2009 04:13:04 +0000

Now we want to think OUTSIDE the box (aka RRSP).

What should we keep outside of the RRSP or Tax Deferred Shelter?

Well, after you maximize your RRSP’s and TFSA, then you can keep investments in the “spillage”

Basically you want investments that are the least “taxing” to you, to keep outside of an RRSP.

Say HELLS NO if you can help it, to:

bonds
GIC’s
money market funds
foreign equities/ stocks that have robust dividends
basically anything that is taxed at 100% your marginal rate to you

Say YES PLEASE, to:

Canadian stocks with dividends (these are actually given PREFERENTIAL tax treatment- the government is kind to us when we are kind to our Canadian corporations)
Any stocks (capital gains are given good tax treatment)
non-dividend foreign stocks (e.g. stocks on the NYSE that don’t give out dividends)
equity type mutual funds
risky investments (you definitely don’t want to keep these in an RRSP because once you lose that contribution room, you’re screwed)

It may be nice to receive $100 interest from a GIC that you have maturing. But if you don’t keep it inside some sort of tax shelter (RRSP or TFSA), then that $100 is really $70 if you are taxed at 30% of your income (marginal rate).

On the other hand, if you have $100 investment gain from a stock, then that is considered a capital gain, and only 50% of that amount is subject to tax. So $50 would be subject to the 30% tax, so for that $100 you get to see $85 of it, not $70.

I personally was keeping everything and anything in my RRSP intially (except for GIC’s!!) and after I did some researching I realised that I should be more “tax efficient”. So now I put GIC’s and bond index funds in my RRSP, to shake things up a bit.

What are you keeping in and out of your RRSP/TFSA tax shelters?

What’s an MER?

young — Fri, 04 Dec 2009 04:53:52 +0000

No, I don’t mean Creme de la Mer (the uber expensive face cream), I mean MER, otherwise known as Management Expense Ratio.

From my experience, your investment advisor won’t really tell you about this until you ask for it, or look into it yourself.

MER’s were created for mutual funds. Mutual funds are great in a way that it provides diversification (you can get many stocks in one basket, instead of purchasing a stock one by one separately, so you can have holdings in different sectors- which minimizes risk). MER’s exist because someone needs to manage the fund and they need to get paid to do it, they’re not volunteering (as much as that would be great, it’s not the case).

The cost of an MER varies. It can be anywhere from 0.4% to 3.2% (ballpark range). So if you’re thinking of compounding money, it would be a big deal to cut the MER down as much as possible.

So let’s say you invest $5000 into a fund with an MER of 0.4% (e.g. money market funds, TD banks efunds, ETF’s). After one year, you would pay $20 in fees.
If you invest the same $5000 into a fund with an MER of 3.2%, you would pay $160 in fees. That’s a $140 difference! And if you pay that over 10 years, lets say- it’s even more (>$1500 worth of money spent managing your fund)!

So the point is you want to cut the fees down if possible.

So where does that money go? If you check out the chart here, supplied by The Investment Funds Institute of Canada, 40% of the MER goes to your investment adviser, and 40% of it goes the mutual fund company (e.g. Franklin Templeton, Investors Group (eek), Manulife, BMO). The other goes to administrative costs and GST (and the impending HST- but that’s another post).

where your money goes

Besides, if you’re not making money on your investment, or (gasp) are losing money, you’re still paying for the MER.

So next time you’re out to buy a fund, be financially savvy (or at least pretend) ask your adviser what the MER is. Make sure it’s not too high.

Mutual Funds Basics