Friday, March 27, 2009

No Money? Poor? Doesn't matter: Open a TFSA

Why? What's the difference between a RRSP and a TFSA?
  • An RRSP contribution is taken from *pre-tax* earnings. Withdrawals (before retirement or outside of special programs such as the Home Buyers Plan) are taxed as income with a penalty.
  • TFSA contributions are after-tax income, but all interest earned does not need to be reported up to a $5000 limit per annum (accumulated over the life of the account). <-- This is the key part
Even if you don't have money (like me now), it's a good idea for you to open this account *ASAP*. Why? Because even if you can't make the $5000 contributions, you can accumulate the limit you are permitted to contribute for the day when you can make contributions (or if you get an unexpected windfall). At some banks, the minimum required to open an account is $25.

In the meantime, you can accumulate your contribution limits year-over-year in order to contribute in greener times. If you are making money now, it's a good tax-free savings vehicle which you can withdraw from today (unlike your RRSP) without penalty.

The suggested investment strategy is to use the TFSA to hold GICs which are traditionally taxed at high rates (making them generally unattractive). However, since this account shields you from taxes, the equivalent "before-tax" calculation translates into a much higher yield (and a better Sharpe ratio - same risk, more reward).

For full details, check out the Canadian Government TFSA website and speak to your financial advisor.

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