TFSA's- I Opened The Account, Now What?

I think by now, most Canadians are familiar with Tax-Free Savings Accounts (“TFSA’s”).  In today’s blog, I will provide a quick summary of TFSA’s, but I also want to veer off  into a discussion of the growth potential of TFSA’s and how the actual deployment of your TFSA funds will affect you from an income tax and investment perspective.

TFSA’s have been in existence since 2009. You can contribute up to $5,000 a year into a TFSA and you can carryforward unused contribution room. There is no income tax deduction for contributing to a TFSA; however, the income earned inside a TFSA is tax-free. In addition, you can withdraw monies from a TFSA tax-free at any time and can re-contribute the amounts you withdrew anytime after the year of withdrawal (i.e. if you withdraw money in 2009, you can re-contribute beginning in 2010).

Initially, I found my clients were indifferent to TFSA’s, however, with the banks and investment houses pushing these accounts, most clients now have TFSA’s.  I think the fact you are investing only $5,000 a year in a low interest rate environment has caused many to look at the account as small potatoes. However, they seem to snap to attention when I inform them that if they contribute $5,000 a year for 20 years at a return of approximately 4% they will end up with around $150,000, and if their return is closer to 6% they could end up with around $200,000.

Once you realize the potential growth power of a TFSA, I think you then need to get a handle on what the TFSA means to you. Is it solely a rainy day fund? A tax-free replacement to your regular trading account? Something in the middle?

After answering the above question, you or your advisor must then address how you invest your TFSA funds. If your TFSA is a rainy day fund, clearly you and your advisor should ensure you hold risk-free investments such a GIC’s, money markets, etc.

But what if you, like many of my clients, are a higher net worth individual and are essentially just moving money from your trading accounts to your TFSA? As a Chartered Accountant I cannot advise you on what to invest in, but I will tell you what I have seen.  Many clients have just “thrown” their TFSA funds into GIC’s or Money Markets. Others have placed the funds in ETF’s, mutual funds, etc. looking at the TFSA as a long term growth investment. Some of my more sophisticated clients have been stock pickers and purchased higher growth stocks to try and maximize the tax-free aspect of the TFSA. The result is that some clients have $20,000 to $30,000 in their TFSA’s today, while other clients have picked incorrectly and have only 30% to 40% of their original investment remaining.

Whether you are the ETF-type, Mutual Fund-type, or stock picker, what you have to understand is that the tax-free aspect of the TFSA may come at a cost for equity investments. If your investments increase in value, at the high rate in Ontario you have saved 23% in income tax on your realized capital gains within your TFSA. However, if your investments decrease in value and are sold in your TFSA, you will have forgone the capital loss you could carryforward outside your TFSA. Very clearly, you are playing off a potential tax-free capital gain against the risk of incurring a capital loss which is forgone.

In conclusion, once you invest in a TFSA, you need to consider the significant growth potential as the years march by and discuss with your investment advisor your investment strategy on the funds accumulated.

For the Love of Football?

I am a casual football fan. I usually only watch when there is a specific game of interest or nothing else on TV. However, the last few years I have been in a suicide football pool (initially created by my son’s hockey coach to raise money for the team) where you pick a winner each week and are eliminated if you select a losing team. It is incredible how much my level of interest and awareness of all things NFL has increased since I joined the pool. I now follow ESPN’s top picks, watch the NFL Network previews of games, etc. to get all the facts for my weekly pick.

I know my friends have had the same experience. However, except for diehard NFL fans, we all have the same response once our teams are eliminated - complete indifference to the NFL. Whereas the week before I was eliminated I could tell you the injury list for each team, two weeks after I am eliminated I cannot even tell you which teams are playing.

It just makes one realize how intertwined the NFL’s success is with legal and illegal betting and football pools.