Tax-Free Savings Accounts Get Another Boost

The TFSA may turn out to be the greatest gift ever given to the Canadian taxpayer. All it needed to do was grow up. And that, it’s rapidly doing.

The program began humbly enough in 2009, allowing all Canadians age 18 or over the opportunity to contribute $5,000 per year (non-deductible). Now, recognizing the inflation protection built into the TFSA rules originally, the Federal Government has announced that 2013’s contribution limit (and all future years) will be 10% higher, or$5,500.

As of January 1, 2013, that means individuals could have put in as much as $25,500(4 years 2009 thru 2012 at $5,000/year, plus $5,500 for 2013). Of course, with some luck in the markets and re-investment of the dividends, the actual value of TFSA accounts should be significantly higher at this time. A married couple could have over $51,000 in these accounts, by next January. How is yours doing?

Government statistics tell us that 8.2 million Canadians have opened TFSAs, but about 75% of those are for less than the maximum possible. Further, about 80% of the nation’s TFSAs are invested in savings accounts, or GIC-type investments.

Now, of course, the possibility of losing money on the stock market abhors some people so much that they are happy to forego any possibility of a significant gain in the future in order to have the ‘security’ of a fixed income deposit. Unfortunately, the yield on safe investments is so low these days, that the tax-free status of TFSAs is essentially wasted on these sorts of investments. Since inflation usually runs at, or higher, than the after-tax returns on GICs, there is a gradual erosion of wealth over time if you stick to those types of investments.

TFSAs appeal because of their flexibility. As an example, say you make a lucky investment in some resource stock, that grows to a market value of $50,000. If you want, you could sell that stock inside the TFSA tax-free, and then extract the cash to splurge on, say, a boat or a new car . . . anything. At some date in the future, you could choose re-start your TFSA by replacing the $50,000 back into the TFSA, and pick up where you left off: with $50,000 in the account, plus the annual limits (now $5,500 per year) for the years that you missed to that point in time.

However, if you plan to extract funds, it’s important that the replenishment be no earlier than the calendar year following the calendar year in which the withdrawal was made.

Investment advisers will tell you that a prudent mix of fixed income and growth is generally a sound strategy (unless you are a senior, or in ill health, and thus unable to wait out any (hopefully, temporary) recessions or market setbacks. Our clients generally save through multiple vehicles: ordinary unregistered accounts, RRSPs or IPPs, holding companies, or TFSAs. So, they have their choice as where to place different types of investments. In our view, the TFSA is the place for equities and other investments that have a chance of a superior future return. Savings accounts, while they have their place, are not the best choice for TFSAs.

Here’s an example to illustrate our point: take a person with $200,000 to invest who feels comfortable with 25% of their total funds invested in equities. That person might choose to have all of their TFSA funds in equities ($25,500), while the rest ($174,500) would be invested in preferred shares, mutual funds, GICs or bonds or whatever, inside their RRSPs, holdcos, or elsewhere (plus, over and above the TFSA, there would be about $24,500 to be invested in equities, as per the ‘25% equity’ overall guideline).

We’ve yet to meet someone sticks that closely to any given investment criteria, but the point is made. TFSAs are the one great place to ‘swing for the fences’. And everybody needs to accumulate financial assets – too many of us have most or all of our personal net worth tied up in real estate. Unfortunately, unless you plan on renting out a portion of it, houses can’t provide you with a pension. If push comes to shove at retirement time, you might have to sell your house. Millions of Canadians, we are told, apparently have the same idea. What this will do to real estate values down the road is anybody’s guess.

The lesson: savings for retirement need to be part of everybody’s financial plan, regardless of age. And TFSAs can help.

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