This year marks the third anniversary of the Tax-Free Savings Account, and while the plan is gaining in popularity, there are still some common misconceptions about what the plan is and how it works.
For example: some still believe that the TFSA is a bank account — one that will pay some interest (that will be tax-free), and will allow for unlimited withdrawals. Subsequent contributions will be limited, however if you do withdraw funds you will be able to re-contribute without affecting your $5,000 per year limit.
This is all true, but is also misleading.
You can open a TFSA at a bank, which pays some interest, and you can withdraw at any point and re-contribute at a future date.
But there is one catch: You have to wait until the following year to re-contribute.
This was one detail that investors and some institutions missed when the plan first became available. As a result people were effectively treating their TFSAs like bank accounts — withdrawing and re-contributing with some frequency.
The problem is: there are penalties for over-contributing in a given year, and these penalties were being assessed as a result of the general lack of understanding of the rules on the part of both investors, and their financial institutions.
Fortunately, since the problem was sufficiently widespread (affecting over 70,000 Canadians as well as some very large financial institutions who did not fully understand the rules), CRA provided relief by allowing investors to apply to have the penalties waived, with the application deadline being August 10 of last year. But going forward there will be no such relief.
While this is all water under the bridge, investors should, nonetheless, consider re-evaluating what they hope to achieve with a TFSA, since treating it like an everyday bank account doesn’t work very well. Ideally contributions to a TFSA should be looked at as more long-term in nature.
The other reason to consider alternatives to high-interest savings accounts involves the rates. A survey of Canada’s banks reveals that you would be lucky to receive two per cent, with most of them actually offering less.
I will concede that short-term interest rates are very low right now. But here is my point: if two per cent (or less) is all you are going to get, why bother?
On a $5,000 TFSA contribution for someone with a 31 per cent marginal tax rate you are saving a whopping $31 in taxes.
Okay, it is better than a kick in the leg, but I can’t help but look at that as a waste of a very good tax shelter. If you want to shelter investment returns why not invest in something that provides returns that are worth sheltering?
Consider a self-directed TFSA offering the same investment options as a self-directed RRSP.
For more information please feel free to call or e-mail.
Jim Grant, CFP (Certified Financial Planner) is a Financial Advisor with Raymond James Ltd (RJL). This article is for information only. Securities are offered through Raymond James Ltd., member CIPF. Insurance and estate planning offered through Raymond James Financial Planning Ltd., not member CIPF. For more information feel free to call Jim at 250-594-1100, or e-mail at jim.grant@raymondjames.ca. and/or visit www.jimgrant.ca.
