Getting Started, Part 2

So we've finally gotten off our butts and decided to take action, and start down our path to financial freedom. There must be a thousand questions you want to ask. Now what? What do I do? What do I buy?

Why not begin by going over the different types of accounts you can use to invest with.

Today, I'll go over the best investment vehicle account in Canada, the Tax Free Savings Account (TFSA)




Tax Free Savings Account (TFSA)

Do not be misled by the name, this account can be more than just a savings account. It can be used to hold many kinds of assets. GICs, mutual funds, bonds, stocks are all able to be bought inside a TFSA. Income and capital gains earned inside this account are tax-free, which makes it great! An additional benefit of the TFSA is when you retire, withdrawals won't count as income (like RRIF) and thus will not result in the claw back of other government freebies :)

There are two major caveats to the TFSA that need to be noted.

One
The first is that due to lack of a tax treaty for TFSA, withholding taxes from foreign income sources inside this account are not recoverable. Thus I generally prefer to hold Canadian income producing assets in this account

For example:
If you had 100 shares of Scotiabank (BNS), a Canadian company, the current quarterly dividend of 52 cents (as of Mar 1 2012) would net you $52 every 3 months. If you held these shares in a TFSA, there is no withholding tax, and no tax payable at tax time.

On the other hand, if you had 100 shares of Emerson Electric (EMR), a US company, the current quarterly dividend of 40 cents would net you $40 every 3 months. If you held these shares in a TFSA, there would be a withholding tax of 15%, or $6, that is completely unrecoverable, netting you only $34 every 3 months

Similarly, if you had 100 shares of Novartis ADR (NVS), a Swiss company, the annual dividend of $2.46 would net you $246 per year. If you held these shares in a TFSA, there would be a withholding tax of 30%, or $73.80, that is completely unrecoverable. In this scenario, normally half of the 30% is recoverable at tax time, but inside RRSP or TFSA, it is not recoverable at all.

Two
The second is that in any given calendar year, if you withdraw any amount from the TFSA, you can not re-contribute it to the TFSA until Jan 1 the following year.

For example:
Jan 1 2012, TFSA room remaining = $5000
Feb 1 2012, you contribute $3000, remaining room is $2000
Mar 1 2012, you withdraw $3000, remaining room is still $2000
Apr 1, 2012, you contribute $2000, remaining room is $0
no action for the rest of the year
Jan 1, 2013, your new TFSA room is $5000 (amount for 2013) + $2000 (amount withdrew in 2012)


As you can see, it is very important which of your investment accounts hold what kind of assets, because it can make a very large difference in the amount of income you receive. Also, it is important to understand the rules of the programs to make sure you do not get penalized.

TFSA is the most important account a Canadian can have. I recently saw some article that shocked me with the numbers for how many canadians had a TFSA account, and how many even knew what it was.

Do yourself a huge favor, open a TFSA account today!