The TFSA is Perfect for Emergency Funds

As we round out of 2008 and into 2009 the newest new thing is the Tax Free Savings Account. The TFSA was announced at the beginning of 2008 for release in 2009, but some FIs have been quick off the mark in introducing the product.

Canadian residents 18 and older can save up to $5,000 every year in a TFSA. You can have as many TFSAs as you wish, but the $5K contribution limit applies across all accounts.

While the contributions aren’t tax deductible, all the income earned in a TFSA is tax-free. If you can’t save $5,000 this year, don’t sweat it. Your contribution room can be carried forward to future years. So if you can only stick $2K in for 2009, in 2010 your limit will be $8,000 ($5K for 2010 and $3K carried forward from 2009.) And, by the way, those limits are going to be indexed to inflation in $500 increments, so watch for increases in limits over time.

The bestest thing about the TFSA is its flexibility. You can take money out of your TFSA at any time for any purpose, without losing the contribution room, which makes this account the number one choice for socking away an emergency fund. So even if you take money out in one year, you can put it back the next, without affecting that year’s $5,000 contribution limit.

Since neither the income earned or withdrawals from a TFSA affect a body’s eligibility for federal income-tested benefits and credits, the TFSA may become a great way for lower-income Canadians to set something extra aside for retirement without having to worry about how it’ll impact on their government benefits.

People saving to buy a home will also love the TFSA since it never has to be repaid, and you can re-use the contribution room for something else once you’ve accomplished your home-buying dream. And people looking for a way to income-split will love the TFSA because a higher-income spouse can contribute to the TFSA of a lower-income or stay-at-home spouse, without the income earned by attributable back to the higher-income spouse.

The TFSA is also the perfect place to park that money you’re eventually going to use to buy a new car, repaint your house, or go on a splendid vacation… any kind of planned spending for a big-ticket item.

You can hold any investment you can buy for your RRSP inside your TFSA, including stocks, bonds, GIC, and mutual funds. But you should probably stick with interest-bearing investments. Why? Well since all the capital gains inside TFSA is tax free, it also means any capital loss can’t be claimed to be offset your other capital gains.

The big thing to watch for is the fees levied by the FIs offering the new TFSA. Don’t be so blinded by the tax-free income that you buy your account from some provider who then gouges you with admin and withdrawal fees. They’ll try. It’s up to you to make sure they don’t succeed on your back.

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Gail Vaz-Oxlade

Gail Vaz-Oxlade wants YOU! Join MyMoneyMyChoices.com to get smarter about your money and help others get smarter about theirs. Isn’t it time we eliminated financial illiteracy? Come find me on Google+ and on Twitter.

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47 Responses to “The TFSA is Perfect for Emergency Funds”

  1. I’ve already opened my account and have $1500 scheduled to be deposited on January 1!

    I’m happy to have this option, and am even happier that the interest rate is pretty good – PC has it at 3.75, which was the highest I’ve seen so far.

  2. I’ve already set mine up with ING Direct…I’m not really sure what I’m saving for right now, but I put 5% of my income in there, then 2.5% each to my emergency fund and my savings for a trip I want to take.

    Is it a bad idea to put retirement savings into TFSA’s?

  3. Karlene – it is not a bad idea to put retirement savings into TFSA’s. Keep in mind a TFSA can hold bonds, stocks, mutual funds, just like an RRSP. Your only limit is the $5K a year which is somewhat low for a retirement plan. But as part of your retirement strategy it should definitely be used. Some people are suggesting using a TFSA to hold your most risky investments, since the return is tax free (unlike an RRSP). So in other words if you invest $5000 into a pharmaceutical company that comes out with a miracle drug and you sell it for $15000 then you don’t pay capital gains taxes. It’s an interesting strategy at the very least. This for once is something the government got right.

  4. There’s fairly comprehensive coverage of TFSA’s at the Wealthy Boomer’s blog – a four part series…

    http://network.nationalpost.com/np/blogs/wealthyboomer/archive/2008/12/01/how-to-access-the-4-part-tfsa-series.aspx

  5. Maybe not the most risky investments, but the most likely to have the largest return. The most risky have the highest probability of going way down in value and then you can’t deduct the loss for tax. That’s the consolation prize of losing money, so I think you’d want to keep that ability. I think the best thing is to hold blue-chip stocks in the TFSA because they aren’t as risky as your most risky investment and they typically provide greater returns (which will be tax free), than savings accounts/bonds. Don’t forget that your contribution room increases with your returns, so more returns means you can take out more and recontribute more later.

  6. Gail, thanks for finally getting around to this topic. It is indeed a very interesting product that “the government got right”. I do believe I heard that when you take out money you cannot put it back in until the following year. Example: $5,000 in account, but $2,000 is taken out. So you would have to wait until the next year to put $2,000 back in. Does this sound correct to you?

  7. Geoff, I’m confused. I thought only up to $5000 was tax-free, regardless of the investment. Does it really include ALL interest earned on the investment? Wow!

    Emma, I have a PC savings account too. But with the announcement yesterday from the Bank of Canada that the interest rate just went down 1%, PC’s interest rate fell to 2.75%.

  8. Saver Queen:

    Thanks for the heads up! My Savings Plus account dropped to 2.75%, but the TFSA is still at 3.75% for all savings.

    I was wondering if this account would fluctuate as Prime does too.

  9. Emma, thanks for letting me know! I wonder if the TFSA willl drop. I am considering getting a PC TFSA too.

  10. All great information as year end bonuses for the lucky few approaches.

    TDDUP Life Planner arrived yesterday. Lots of useful information in plain English in a great format! Thanks Gail!

  11. Regardless of where you put your money in 2009, just make sure you SAVE, SAVE, SAVE! It’s always nice for added perks on saving accounts.
    My mantra for 2009 is “Spend less, save more”. This upcoming year my budget is on a diet : ).

  12. SQ – all interest is tax free. The $5000 limit per year refers to your contribution limit per year. That said, it would have to be a yahoo-like circa 1995 investment to make a huge return off 5K. Derek makes an excellent point about capital gain losses not being able to be declared. However that would apply only if the losses were realized (sold).

  13. Where to put money within the TFSA?
    It depends on the purpose of the money!
    – Emergency money: cashable high interest investments.
    – Pre-planned purchase (short term): GICs with higher interest with maturity dates prior to your purchase.
    – Long-term savings (pre-planned purchase, general savings beyond those mentioned above, pension): follow your investment profile (percent in safer investment instrument, percent in equity).

    The investment vehicle depends on the PURPOSE of the money. If you have nothing available beoynd your emergency money, don’t bother yet worrying about investments in equities! If you have more than $5000 available on January 1st, 2009, the argument ‘guaranteed interest in GIC’ (which are taxed at 100% otherwise) versus possible higher returns on capital gain investements (which are taxed at 50%) is a valid!

  14. Has anyone had any success in having a “traditional” bank waive their monthly service charge because ING & PC Financial have no fee banking? I am thinking of transferring to save $12.95/month service charge.

  15. Elaine – some banks ‘waive’ their monthly service charge provided you have a certain minimum balance in your account. For ex, TD waives the service charge if you keep a minimum of $3000 in your account. Note that you have to keep the balance for the whole 30 day period. If at any time your balance goes below $3k, you are charged the monthly service fee.

  16. Thanks Haidee – we do have our account with TD – but I am wondering if I tell them I will switch, if they will waive the fee. I would rather keep my $3000 in a savings account earning interest and have a no fee account. Leaving $3000 in my TD chequing account earns no interest.

  17. avatar CluelessButInterested Says:
    December 11, 2008 at 4:14 pm

    With respect, I so do not understand what the heck y’all are talking about when you say you can use the TFSA for GICs, RRSPs, mutual funds etc!?! I’m trying to wrap my measly little brain around investing but I just don’t understand – how can I put an RRSP or a GIC, or anything else except actual money, inside a savings account? Could someone please elucidate but try to keep it as simple as possible? … oh yes, and will every bank (I’m with HSBC and CIBC) have a version of a TFSA?
    Thank you, thank you, thank you!

  18. I opened a TFSA w/ ING today and transfered the money that was in my regular savings account with them into it. I also set up an automatic monthly transfer from my chequing account.

    I have the same question as Clueless above as I don’t understand how you can put investment vehicles inside this savings account.

  19. Clueless – every financial institution will undoubtedly be offering a TFSA come January 1st.

    TFSAs and RRSPs are not investments themselves, they are simply accounts. The banks are offering savings accounts which would mean you have cash in your TFSA that earns interest at the offered rate. Banks may also offer you the choice to hold GICs, Canada Savings Bonds and mutual funds in your TFSA. If you wanted to buy stocks or bonds you could open your TFSA through an on-line brokerage firm. The possibilities are wide – the easiest thing to do is open a cash account through a bank like PC as others have indicated. HOpe that is helpful!

  20. I think I’m confusing myself regarding withdrawals and contributions.
    I contribute $170 a month to my ING TFSA -it is my emergency fund. However, in the new year when it officially starts (I opened the pre-TFSA in October), I will actually be losing my job (contract) and potentially be unemployed for a hopefully short period of time and will need to withdraw some money from the TFSA. If I take out money, does that mean I can no longer contribute for the year? Or does it mean if I take out, say $500, I can still contribute but will have to stop contributing when I reach $4500 (because I took out $500)? And then I can put the $500 back in the next year on top of the $5000 limit?
    thanks in advance!

  21. Gail – that was so perfectly explained! Thanks a bunch : )

    Elaine: I work for FI (not TD) and I would recommend calling your bank to ask them to review your account and see if that is the best option for you. Maybe there is a more cost-efficient account for your usage.
    Most banks also offer accounts that will waive you fee with minimum balance like Haidee mentioned. Do you have a mortgage with your bank or other loans? Will they charge you a fee if your payment need be a day late? Will they waive your fee provided your mortgage is with them?
    Even if you decide to switch banks, calling them will help you decide what account type will be good for you as you’ll be more aware of how you use your accounts, if you are not already.

    Another thing to keep in mind – let’s use the example that with your account you need a minimum $2000 in the account to waive the monthly fee of $12.95. If that was in a higher interest account earning 3% it would earn you $60 over the year (without the compounding). Compare that to the $155.40 you would have spent on service fees – you’re getting more of a return for your investment.

    While the virtual banks have lots to offer, you don’t have that same face to face service available to you. I find that my clients who also deal with the virtual banks get frustrated with the difficulty to place a stop payment on a cheque or purchase a bank draft. I believe NSF fees are higher as well. So while you may pay a monthly fee, be sure to inquire about how they can serve your other banking needs.

    Hope that helps!

  22. Lise – good questions. I think I’ve got it but please check. Technically you can only contribute to a TFSA beginning in January. So though you’re putting money into “it” right now, you’re really just putting money in a regular chequing account.

    On Jan 1st your bank will transfer your existing savings into your TFSA. This will count against your $5000 a year limit. So let’s say you put aside $1000. This means you have $4K left to contribute.

    Whatever you withdraw you can put back at anytime. So you pull out $500 from your $1000 amount. You can later put in that $500 this year no problem. If you wait, next year you can put in $5500.

    Anyone else think that’s right (wrong?)

    Clue — Julie explains it well -part of the problem is that though it’s called a Tax Free Savings Account (TFSA) it’s really just a Tax Free “X” Account (where “X” could be Investment, Savings, Bonds, etc). None of the banks have setup anything other than savings though since they can’t until January.

    Almost every bank and investment house in Canada will have a TFSA but not all will be created equally in terms of fees and services.

  23. Geoff – If you take out any money in a calendar year, i.e. $500 you have to wait until the next year to put it back in. Thus your limit the next year will have the additional $500 you can put back in.

  24. Geoff: Not quite.

    For withdrawals, while you keep your contribution room, you can’t recontribute until the following year. Don’t take my word for it, take KPMG’s:

    http://www.kpmg.ca/en/services/tax/tnf/tnfc0827.html

  25. You don’t want anything in a TFSA account that is even slightly likely to lose money (ie many stocks) for 2 reasons:
    1) Most importantly, you can’t take deduct any losses from your income tax.
    2) Taxes on capital gains (like stocks) are lower than almost any other income type anyway.

    One question I have: PC currently has the best interest rate on their TFSA at 3.75. However, what’s to stop them from reducing it after people deposit their money? Especially since it can’t be taken out and re-deposited elsewhere (perhaps transferred, but there’ll probably be a fee for that – there is with their RRSP).

  26. Thank you for the info, Geoff!

  27. We are considering moving our GIC money to a TFSA.

    Does anyone know if both my husband and I will be able to each have a 5000.00 TFSA?

    Or if as a couple we are allowed a limit of 5000.00.

    Thank you in advance!!

  28. Leanne, it’s as an individual. You’ll need to open separate accounts – but I’m fairly certain you can have as many TFSA’s as you wish, so long as you keep the amount under the current allotment per person.

    So yes, you can each have $5000 a year :)

  29. I’m not clear on something as posts above are contradicting each other.

    Gail, perhaps you can clarify.

    If I put $1000 into the account and then take out $500 does that mean I can only put it another $4000 or can I put in $4500?

  30. I think I found the answer to the above on ING’s website:

    “If you take money out of your Tax-Free Savings Account, you don’t lose the contribution room. You get it back in the following year. ”

    So this tells me that if I put in $1000 and then take out $500 I can only put in another $4000 not $4500.

  31. This is from the PC website…

    Funds are not taxable even when withdrawn. Any withdrawals made from your account during the year will be added to your contribution room for the next calendar year. Transfers between Tax-Free savings accounts will leave your annual contribution room unchanged.

  32. Thanks for clarifying. I had worked myself into some twisted logic and confusion with the rules. :)

  33. Hi,
    I am new to this website, and am trying to find my way around. WE have our financial issues and are trying to get back on track. I do have a question about TFSAs though, and maybe it’s a stupid one, I’m clueless too. We already have RRSPs set up, and have for about 5 years. We withdrew fromt hen 3 years ago to help with purchasing out first home. In January, can we transfer our existing RRSPs into a TFSA?

  34. Boy, you guys were hot on this topic.

    Melissa: There is no reason why you would transfer an RRSP to a TFSA since the minute you pull the money out of the RRSP it is taxable. You would, instead, use the RRSP Home Buyers Plan.

    Tammy: Taking money out and putting it back. Any money you take out of the plan may NOT be put back in the same year but will be added to your next year’s contribution limit. So your limit for the current year would be $4,000 since you’d already put in $1000. Next year your limit would be $5500 to recapture the $500 you took out.

    Leanne: There are no “couple” limits. Nothing in the Canadian tax system does “couples”.

    To all of you who are a little fooled by the word “savings” in both the RRSP and the TFSA. The reason you’re confused is you are thinking as a “savings” account (the noun) as opposed to “savings” (the verb), which is the act of taking money out of your cash flow and putting it away for a later date. Each of these plans is using “savings” as a verb.

    As for what you should hold in your TFSA, well won’t it be interesting to see how people end up using it?

  35. @jay: There’s nothing to stop PC from reducing their interst rate from 3.75% other than customer and market pressures. I know that the interst rate that I earn on my regular savings account with them has gone down since I joined the bank two years ago.

    I signed up for my account a few weeks ago and the very helpful phone agent said that there are no fees for withdrawing your money. So if you find a better interest rate somewhere else, you can jump ship and move your TFSA somewhere else. But it’s the best rate that I’ve seen, by far.

  36. @Stephanie

    Thanks – I just wonder if they’ll charge fees for a mid-year transfer (vs. withdrawal and deposit, since we won’t be able to deposit it till the next calendar year). I guess December is when you’d ideally withdraw/re-deposit TFSA money.

    PCF doesn’t charge for withdrawing RRSPs, for example, but they do charge $50 for transferring it to another institution.

  37. I just got the fees disclosure from PCF. If you want to transfer your TFSA to another institution, it’ll cost you $50. So if they lower the interest rate, there’s not much you can do about it unless you’re getting more than 1% for the entire year (on $5k).

  38. This is great information, especially the part about watching out for fees, this could be the difference between a TFSA that makes sense and a TFSA that leaves a bad taste in your mouth. The follow-up information is especially valuable and insightful. Thank you.

  39. Gail states “You can have as many TFSAs as you wish, but the $5K contribution limit applies across all accounts.”

    Does this mean that if you are dealing with 3 different institutions/banks, you are entitled to 3 TFSAs with $5000 limit each? ie. $15,000

    OR

    Despite dealing with 3 banks, and opening 3 TFSAs, the total contribution would be only $5000 for all TFSAs.
    ie. Bank A: $2000
    Bank B: $1500
    and Bank C: $1500

    Can someone please clarify.

    Thank you in advance.

  40. Amparo:

    You have a limit of $5000/year, so it’s your option B in your question. Hope that helps!

  41. Jay:
    The other option with the PCF one is to remove all the money in December, and then put it into another bank in January.

  42. If you transfer your TFSA to a different financial institution, there will usually be a fee. Ask the bank you are transfering it to if they will cover the transfer fee. Most banks want your business and will cover the cost for you.

    CluelessButInterested – Look at a TFSA or an RRSP as an umbrella. You can invest in a savings account, GIC, mutual fund, etc under the umbrella, but the invesment is the savings acount, GIC, etc not the TFSA or RRSP.
    The umbrella is just different tax rules that apply. In a TFSA, the funds grow tax free, however, you don’t receive a deduction on your income tax. When you withdraw the funds, you do not pay income tax on the funds. In an RRSP, the funds grow tax as well, however, you do receive a tax deduction on your contributions. When you withdraw the funds, you pay tax on the full amount…not just your contributions.

    Most banks have calculators that show you how the two investments compare. It is quite interesting to see the differences. A TFSA is better is you do not need the tax break now, however, $5000 isn’t much to contribute towards your retirement and for emergency savings.

  43. Read the rules!
    Once your money is in… don’t take it out unless you need it!
    PC Financial dropped their interest rate for the TFSA (from 3.75 to 3.05%). I was wondering how long it would take! Variable interest rates can be annoying!

  44. i too would like to transfer my TFSA from ing to td, but dont want to pay any fees…
    i deposited the $5k in may2009 at ing
    i assume based on above discussion, that i can withdraw the $5k on dec31, 2009
    and deposit it into the td tfsa jan 1, 2010 without incurring any tax consequence…

  45. Don’t forget that you can also buy stocks, or mutual funds inside your account. I think that they way the stocks are now it is a pretty good idea to pick up a Mutual fund, I would not suggest buying stocks because individual stocks are volataile. Find an industry that you think will do well over the next few years (I think manufacturing will have a nice recovery) and buy a mutual fund. I bought a High yield mutual fund (which means on top of the stocks going up I also make money off of dividends) and I bought an energy mutual fund as I think they will recover nicely.

  46. True, you can buy pretty much anything in your TFSA. I found a website that explains that very simply: http://www.rrsptfsa.com

    The way I understand is that TFSA is just another account type in which you can put what you what, depending on the products offered where you open your account: stocks, funds, etf…

  47. Remember that TFSA is not an investment, it is a just a type of account. We should determined what type of Investment Vehicle we agoing to invest and registered as TFSA. Only one thing I would like to add that if you are really want more better RoR for your investment and at least 75% a guarantee for your principal, you should consider Segregated Funds. 10 years maturity and Principal can be reset to current value market, it perfoms like mutual funds, it probate fee free, transferrable. Research it further. I can help you more if you are in GTA and we can discuss further in our office in Scarborough. Good luck! financialcanada@gmail.com.

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