Public Service Announcement: TFSA's

Canadians - have you heard about Tax Free Savings Accounts? They are a new creation by the Government which allows saving after tax money, tax free, starting Jan 1/09. In my opinion, in 20 years these will be much much more important then RRSPs. You have $5,000 of TFSA room per year added every year you file a tax return.

Difference between an RRSP and a TFSA? Here is an example:

You add $5,000 of cash to your RRSP out of "pre-tax earnings". Technically it comes out of after-tax cash on hand but you get a tax credit in the same amount. You can't take the cash out of the RRSP until you retire without triggering tax payments and even then it is taxed at your marginal tax rate. The money that goes into an RRSP is "gone" from a short-term savings/planning point of view (not including the option to purchase a house and then repay the RRSP). Pros/Cons? Tax credit in year 1, interest inside RRSP not taxable, cash when pulled out is taxable (even when retired).

You add $5,000 of cash to your TFSA out of after-tax earnings. You can earn interest (or capital gains) on this amount tax free and can pull the money out at any time. If you pull cash out of the account you can put money back in up to your limit without tax or penalty. Pros/Cons? No tax credit, interest non-taxable, can withdraw cash at any time without penalty.

This is a huge incentive to save and a big invention for people who still have 20 - 30 years until retirement. The fact that you get $5K/year until retirement shows how potentially big this is. If you don't have cash on hand to contribute starting in 2009 your $5K allowance will still roll forward.

TFSA's are great for saving up for a big purchase (house, car, renovations, vacation) and even for day to day savings. There is no reason to have a "regular" savings account at all when you get interest from your first $5K tax free inside a TFSA. In 10 - 20 years, savings accounts will likely be obsolete as $50,000 - $100,000 in TFSA account room will occupy all Canadian's savings.

So why does this matter now? I don't want to push one product but I recently signed up for the ING Direct Canada Tax Free Savings Account. You sign up for an account now, and they 1) add enough "bonus" interest to pay your tax for the rest of 08 and 2) transfer the account on January 1st so you don't miss a day of tax-saving goodness.

Every financial institution in Canada will have TFSA account coming out parties so shop around for the best deal, which may just be with your standard bank if you are looking for convenience. But do so before 2009 so you can squeeze every penny of tax advantage.

More info on TFSA's and a recent poll that says 50% of Canadians don't know what they are/do: here, here and even at the Toronto Star.