Tax free Savings Accounts – Fact, Fiction, or Folly
So I’ve completed some of my Tax Free Savings Account (TFSA) homework and already I’m impressed. If you don’t already have one set up, hopefully by the time you finish reading you will understand you need to get an account established. Just to warn you, if you haven’t already set one up, it’s not a race, you actually should do some of your own research first as there are many options. As always, some options are much better than others are.
To start with, many people are wondering exactly what is a TFSA and how does it work? When I started researching, I was expecting a very complicated answer to this question, but as it turns out, it’s surprisingly simple. It also has some very promising long term implications as a savings/investment tool.
A TFSA is a special savings account that can be opened by anyone in Canada 18 years of age or older (some provinces have an age of majority of 19 which requires waiting one more year). This savings account has a current contribution limit of $5,000 per year and any growth in the principal is completely tax free. This $5,000 is indexed to inflation, but will never decrease below $5,000, so over time you will be able to contribute more in some years and potentially this limit will increase each year.
The part that gets interesting is you can hold the same types of investments in your TFSA that you would also be able to hold in an RRSP. Traditionally this would be mutual funds, GIC’s, bonds and publicly traded securities. Many people are unaware that they can also hold Arm Length mortgages, and Mortgage Investment Corporations (MIC’s) in RRSP’s as well which can also be held in a TFSA.
While mutual funds and securities can be quite volatile as everyone has seen with the stock market lately, GIC’s and bonds however are quite stable with their returns. The problems with GIC and bonds are there is so little risk that the returns are low single digit and after inflation you end up almost breaking even, which is not how you get ahead with an investment.
Opportunities like MIC’s and Arms Length mortgages however tend to be slightly riskier, but are attached to property which I consider very secure, and tend to have fixed yearly returns of high single digit and low double digit. Coupling products like these with compounding interest inside a TFSA creates an opportunity for individuals to generate significant growth over time all tax free.
If you consider a couple each investing $5,000 per year in their TFSA and generating a 10% per year return after ten years the $100,000 invested by the couple would be worth $175,000 and is all tax free. Now if you compare this same situation to a $5000 yearly contribution to an RRSP, with the same yearly growth, you would also have the same amount of money at the end, but when you are forced to withdraw it from your RRSP, you would then be taxed on it!
I’m not positioning this as the end of RRSPs, but as a complementary tool to utilize if you currently have RRSP’s. Or if you don’t use RRSP’s to take advantage of the deduction, you can use the TFSA to save future taxes.
Some great options you have with the TFSA that really help seal the deal is the ability to borrow from the account at any time and then repay the amount you borrowed later. This allows a younger person just starting out to potentially use the TFSA to save money for a down payment on a house tax free. Or a family could use it as an emergency fund that grows tax free.
Another appealing aspect is carrying over any unused contribution room. If you only have $1,000 to add to it next year, you could then add $9,000 in the following year. This will negate much of the value of compound growth, but will also allow you to contribute more in profitable years, and less in slower years, without being penalized.
Now as you are probably aware, every bank and trust company you can find in Canada seems to be offering to set you up with an account. The part you need to be aware of is that the majority of these institutions will only allow you to place the financial instruments like GIC’s, mutual funds and bonds that they offer. If your goal is to put a certain security fund or MIC into your TFSA, you better be sure you are allowed to do that through the institution you are working with.
Much like RRSP’s there are also some companies allowing you to set up self directed TFSA’s, but if you establish your account with one bank, you may incur additional costs transferring it over to another place. This will require you to have a plan prior to randomly starting the account at your closest bank.
I hope you can see some of the positive possibilities available through setting up one of these accounts and I have managed to get you a bit excited about this. I’m currently looking into more information about some of the MIC’s as I think this may be one of the better options to get started with for people. They are have slightly more risk than a GIC, significantly less risk than most mutual funds, and provide a pretty stable return to grow your investment.
So I have now walked you through the basics of Tax Free Savings Accounts, I’m sure I have now opened a new topic with the option of MIC’s and many of you may be wondering how and where to get information on these. Well don’t worry I won’t leave you hanging with this either. I’m working on information on this as well, so if you want to get updated on this make sure you leave me a comment, email me or give me a call. Once again, if there is enough interest I should be able to get it off to everyone sometime next week.
The Opportunity is Now!
It’s a crazy world right now. Businesses are losing billions, the stock market is stinking, some homeowners are losing their homes and people everywhere are looking for money from governments to help them out. Unfortunately, it probably won’t be getting better for a while as this type of news makes for great headlines and will help to perpetuate the problem.
On the other hand, I also know people who are thriving in this turmoil as there is opportunity in any type of market. My favorite opportunity is of course Real Estate and once again I cannot help talking about the HUGE opportunities for people with long term vision that are currently out there.
Unlike Nortel stock (I’m sorry they seem to end up being one of my best examples all the time and they keep becoming an even better example each year they stick around), which has virtually disappeared again, a property is still something you can control and won’t become worthless. When the president of a company you own stock in spends over a million dollars to renovate his office (but doesn’t take a salary to help the company out during turbulent times, what a trooper!), you don’t even get to go visit and see how wonderful it looks. Just try getting past security!
If you own a property (or partner with someone like us who buys properties), you have ownership of something real, something solid and tangible, something you can actually drive by to ensure it exists. I’ve talked to several people involved with the banks, mutual funds and stocks during some of my research on the TFSA article and people are getting excited about 3-5% returns on their investments.
Real Estate will easily double those types of returns over five year periods if you can find quality properties in select areas. I know many of my readers are already Real Estate investors, or have some serious interest in becoming involved, even in an effort to stop the bleeding from their other investments.
We have never seen such a great time for purchasing properties since we started in this business. Prices are down, people are willing to negotiate and there is a huge base of tenants out there looking for quality places to live. I have now heard from several people that there is millions of dollars currently being rounded up by private investors to purchase investment properties in bulk over the next six months.
Forget the fear, forget the despair (and I apologize to the people who are getting laid off as there is real fear for many employees out there) and think about this. How can the value of oil fluctuate over $100? While $145 oil was obviously too high, at the same time, couldn’t $45 oil be to low? Yes, there have been huge cutbacks in usage, and this has built up stockpiles resulting in lower prices, at least currently. What will happen as the hundreds of billions of dollars the governments worldwide are infusing into the global economy start creating traction? In tough times, governments turn to capital projects like bridges, roads, and infrastructure that require workers and energy and help to keep the economy moving forward.
Won’t that directly affect energy and the size of the stockpiled reserves? Oil prices are fickle, as soon as it appears there may be a potential shortage again we will see all the peak oil theorists reappear and we will see new fears about shortages again. Large oil companies are playing into this right now by putting major projects on hold, this in turn decreases future production, perpetuating the large increases in pricing followed by large decreases. It is the cycle of life in the world of big oil.
Will this start occurring in six months? Or will it be two years? We cannot be sure of the exact timing, but like the seasons, we know it will be coming. Do you want to be the one rushing to the hardware store to buy a shovel after you have a foot of snow drop on you? Or do you want to plan ahead and pick up a shovel (or two) while they are on sale and less people are interested in them? This is a direct comparison to the Real Estate market right now, as the planners are preparing to stock up, while others are hoping it won’t snow. You don’t want to be caught without a shovel do you?
In Closing
Wow, what an incredibly long Newsletter to start out my fifth year of creating this monthly source of info. I hope I haven’t bored too many people with this extended version and you are still seeing the value I hope I am bringing.
I’ve noticed that my topics seem to continually extend beyond just Real estate and the economy and over the years, I have floated through everything from motivation, to goal setting to book reviews and now onto Tax Free Savings Accounts. Do I need to tighten this up and just stick with my main topics?
Do you appreciate the extra information and the insights I try to provide you each month? I have such a breadth of interests that I commonly get so caught up in them that I feel compelled to share the information. Fortunately (or unfortunately for some) having access to my own soap box via this blog and Newsletter allow me to share some of this will all of you.
I regularly ask for feedback, and only a small percent of the actual readers ever seem to reply, but if you could please take a minute and send me your thoughts on this, I would love to hear them. And I will reply to each and every email I receive, as I do appreciate the feedback!
We are hoping you have a tremendous 2009 and we look forward to another interesting year with you.
Regards,
Bill and Karen Biko
