Where is the catch?If it sounds too good to be true it must be.Well, that depends upon your marginal tax rate (the rate at which you pay taxes).
The Tax Free Savings Account (TFSA) is essentially a self directed investment plan with a $5000 cap on annual input.The money you invest has already been tax paid through your income tax.The money you invest into the TFSA can build or take losses.You do not claim either for tax purposes.The beauty of this plan as opposed to an RRSP is that you can withdraw without penalty.For instance, let’s assume you withdraw $2500 from your account this year.Next year you can make that up so your allowable investment will be $7500.
Still a good deal right?Well it is if you have the money to invest but the bigger caution here is that it could be a gamble.Remember this is self directed so you specify where the investment is made.Suppose you decide on a vehicle that has been returning 10% over the past couple of years.You make your investment and that fund goes under; maybe it got caught in the US subprime crisis, you have lost your money and there is no recourse; there are no capital gains or losses.Maybe you invest in a solid fund with modest returns then the stock markets start to go down and the hedge funds jump in.You could lose again while the fund makes money on your losses or maybe it goes up.The decision you have to make is when to sell.
So who really benefits?Well, first of all you are supplying money to others to use in their businesses and for that you are going to get a return; if they make money.If not, well there is always next year.
Okay so you already have a high yield investment savings account and it is doing quite well; why should you look at a TFSA?To start with there is the tax advantage.Of course, you will still have to pay administration fees.Just make sure they are front end load.In other words you pay the fees when you buy, not cash in.Those fees could be either flat rate (discounted) or percentage.
But what about your RRSP’s?Should this replace them?If you are already involved in RRSP investment, these can be used to augment them and should be.The reason?The risk.Your RRSP will provide a modest but steady growth where the TFSA could fluctuate wildly with the markets.Remember, your RRSP is fund managed, your TFSA is under your management.The risk is higher, but so can the possible returns.Depending upon the TFSA for retirement savings is not a good idea.If you are already an astute and successful investor, the TFSA provides a good tax shelter.
So why does the government want Canadians to open these accounts?First Canadian consumer debt is at an all time high, but so are savings.Savings are money that is idle and the government want to put that money back into circulation.The TFSA does exactly that.You are investing your savings into companies either through banks or investment firms who will also gain in the process.
There may also be other less obvious reasons the government wants this program.First, they have committed to lowering corporate taxes.This will increase revenues and hopefully make up for the reduced tax revenue.Secondly, the strongest sector in the economy is energy and Canadians will play the “safe” bet and invest in the energy companies who will be able to expand their operations.
So, in the end, if you have the spare cash to invest, then do so, but if not, be penny wise.