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TFSA & You

There is evidence that consumers sometimes make bad investment choices. In the following points there are valid arguments to support the need to save.

·        For example many studies in U.S. have proven that U.S. equity risk has a large idiosyncratic component due to lack of portfolio diversification skills (Goetzmann & Kumar, 2008). They save but they do not save well due to lack of knowledge or low diversification skills.

·        There is a need to encourage people to save.  A study recently conducted for Scotia bank has found that 61 per cent of Canadians are interested in learning more about the new Tax Free Savings Account (TFSA). Of the sample of respondents currently without a TFSA account 40 per cent said they are interested in opening an account prior to January 2009.

·        Similarly many Canadian households are suffering with very high levels of debt.  People are living a ‘credit card’ life with no actual money saved in personal accounts.

A better personal investment strategy?

Beginning in 2009, individuals will be able to contribute up to $5,000 per year. Here are some important pointers to think about the tax free savings account as an investment choice. Unlike traditional investment accounts, individuals will be able to re-contribute funds into the account if they make withdrawals in the future. What this means is that if an investor makes a short term withdrawal to pay for a vacation or their children’s education, they can replace the funds up to their maximum allowable contribution level. This is a great feature for anyone who wants a tax free, short term savings type account that can also earn tax free interest or growth.

This flexibility in terms of use differs from the more traditional investment type account which is designed solely for retirement, the RRSP. The TFSA was not however designed to replace the RRSP account, but to be a valuable addition to the traditional and widely used investment account.

The TFSA model

The general idea of a TFSA is simple; you pay income tax on your money.  Then what is left after that may either be spent or put into a savings account or invested in stocks and mutual funds.  If you decide to put your savings in the TFSA, eventually your money will grow due to capital gains, dividend, or interest and this income will not be taxed.  After your retirement you will have a big secure source of money to rely on.

There are a variety of investments that an investor can select within a TFSA account, including:

·       Cash

·       Bonds

·       GICs

·       Stocks

·       Mutual funds

Unlike taxable investments, the dividends generated or the growth experienced within a TFSA account is not taxed, but is sheltered. And, in addition to tax free growth, the withdrawals from a TFSA are also tax free which makes them popular.

Grows With You

Even if you are unable to meet the golden contribution of 5000$ every year, the balance contribution would be rolled over to the next year.  Hence if you are able to contribute only 3000$ to your savings account this year, the following year you can save as much as 7000$.  The accounts can be opened by individuals planning a smooth retirement, couples planning for a family or their children’s education, and small business owners, etc.

A unique feature of the TFSA account is that withdrawals are eligible for replacement. What this means is that an individual could save money into the TFSA, make a withdrawal to purchase a home or a vehicle and then they could replace those funds to be used for retirement in the future.

A TFSA allows you to grow tax-free investment income (i.e., interest, dividends and capital gains) earned on the contributions made using already taxed income. This account flexibility provides a variety of options for saving money and for sheltering assets from taxation on an annual basis.

Investment Worthy

If your investment strategy is to consistently save small amounts over a period of time with a stable rate of interest you must consider opening a tax free savings account.  By setting up a tax-free savings account you are spared the pain of dealing with volatile stock markets.  If you are investing in stocks and wish to diversify possibly the most conservative asset option is a tax free savings account.

Beginning in 2009 investors of all ages will be considering whether or not the TFSA account is suitable for their investment goals. With so many features and benefits to consider, financial professionals are advising individual and families to begin educating themselves. It is always reccommended you know what your talking about before opening up a TFSA, rather than going in blind and expecting the professional will know you best.

 
 

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