If you’ve visited your local bank lately you’ve probably been asked if you’d like to open a Tax-Free Savings Account (TFSA). The new account offers Canadians a vehicle where they can deposit up to $5,000 annually without paying taxes on the interest earned. 

TFSA holders must also consider how they want to invest their cash — through an interest-earning savings account or through higher-risk choices such as stocks that could provide better returns. Chartered accountants Millard DesLauriers & Shoemaker LLP, warns there hasn’t been enough talk about the risks involved with the new account. 

“The gains are not taxable but in this marketplace people should be aware that losses are not deductible,”.

“If this had come in a year ago and people had gone full-force into this and put their money into the stock market they’d all be looking at their $5,000 being considerably less than what they put in.”

But, if a couple was able to set aside $5,000 annually and invest it successfully, the tax free cash at the end of a decade would be significant:

• $139,700: $100,000 invested, $39,000 earned in tax-free interest (assuming a 6 per cent return)

• $153,000 — $100,000 invested, $53,000 earned in tax-free interest (assuming an 8 per cent return)

In general, most TFSA holders will likely be putting their money into a traditional savings account, with returns between 2 and 4 per cent. But is it still worth opening an account even if you can only contribute small amounts? Most experts say yes.

For clients strapped for cash, Scotiabank, suggests a “pay yourself” savings plan where account holders automatically deposit $50 to $100 every month. An advisor at Scotiabank explained that even if you don’t deposit a full $5,000 in year one, the remaining contribution space gets carried over and accumulates.

Technically, even if you don’t have any money to deposit, it’s still worth opening an account because it will serve as a tax-free haven if you come into a lump sum of cash in the future.

TFSA or RRSP?

If you have the money, experts say the best thing to do is invest in both. Simply put, an RRSP is an investment tool to help you save for retirement. A TFSA is an investment tool that can help you save for the rest of life’s big purchases or make sure you have an umbrella for a rainy day. ”They (the government) picture people saving money and taking it out when they have something special they want to do: buy a house, supplement the education savings plan for their kids, or for a wedding,” said an expert.

“But, on the other hand, there’s nothing to say it’s not another way to accumulate money for your retirement.”

For wealthier Canadians, experts say different strategies will emerge as to how to best use the TFSA. ”Some people who have lots of money to invest — they have RRSPs, they have these savings accounts, they also have securities investments – I think for them likely the situation will be with these accounts is that they’ll put their safer investments in here,” they said.

As a rule of thumb, Canadians in a higher tax bracket will still likely see more benefit from contributing to an RRSP. ”If you’re earning more than $70,000 annually, at a 40 per cent marginal tax rate, then likely you’ll be more in favour of contributing to an RRSP than a TFSA just to get the tax savings,” said experts. ”There’s no tax savings up front from a TFSA.”

Still, Canadians making more than $70,000 annually are “likely to have the money to invest in both plans anyway.”

All of the experts are unanimous about one thing: Talk to an adviser about your specific needs before making any decisions.

Many banks are also charging administration and withdrawal fees for TFSA holders who want to invest in the stock market, so make sure you check first.

Here are a few key points about the new TFSA accounts:

• Canadian residents age 18 or over will be eligible to contribute up to $5,000 of after-tax cash, with unused room carried forward.
• Contributions will not be deductible.
• Capital gains and other investment income earned in a TFSA will not be taxed.
• Withdrawals will be tax-free and you can put back what you took out at a later date.

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