The Gift

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kisses1

Imagine if the government let you take a portion of your income each year, invest it in almost anything, pay no tax on the profits, remove the money when you feel like it and use it for any purpose, then put it back later.

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Now imagine if you could do this for your spouse, too. And your older kids. If you were in the top tax bracket (making $140,000 or more), such a thing would effectively double your investment returns, turning 3% into 6% or 7% into fourteen. It would allow easy income-splitting within the family. And every cent in there would be after-tax income in retirement, no matter how much other money you had. No withholding tax. No clawbacks. No CRA.

Finally, imagine if you and your spouse could instantly open accounts and plop $51,000 in there, add $400 a month for twenty years, then retire. You’d have $414,346. Unlike an RRSP or company pension, you could take out lots or little and pay no tax. You could enjoy a $30,000 annual income top-up (at a return of 7%), send none of it to Ottawa, and still have your four hundred grand.

Well, you have this ability, of course. It’s called the TFSA. As you should know, the annual contribution limit was just raised to $5,500. Now the accumulated contribution room is $25,500, double for a couple, triple if you have a kid over 18.

Let nobody reading this blog think Canadians are moronic simply for the way they treat real estate. Oh, no. This is equally whacked. Our innumeracy is pristine.

Despite being able to shelter all this money from any kind of tax, most don’t. Only four in ten people have a TFSA, even five years after it was created. Of those only half actually contribute to them. And (are you sitting?) eighty per cent of people with a tax-free savings accounts have the money in savings. Yup. High-interest savings accounts paying 1.5% or maybe two. Or a dead-end GIC. (I spoke with a woman this weekend whose TFSA is in a 90-day GIC. “It pays 2.5%,” she said proudly, thinking it will grow that much every 90 days. I wept.)

This is a complete and utter waste of a tax shelter. Millions of people, seduced and ravished by TNL@TB, have been pushed into ‘investments’ which don’t even pace inflation. Their tax-free accounts have been rendered into low-yield, emergency slush funds, routinely raided for vacations and full-body hair removal. It’s also astonishing how many people don’t realize keeping money around for emergencies like job loss or infidelity is a bad idea, when you can get a line of credit costing nothing to maintain.

TFSA money is best invested for growth. No, not those junior uranium stocks the coffee-truck guy is always yakking about, but as part of a diversified and balanced portfolio. Remember, last year the S&P grew by 13% and the TSX by just 5%. International markets returned double-digits and the REIT index added about 7%. Why would you not want a mix of this stuff in an account that F’s paws will never touch?

After all, there’s no way the average house will be gaining in value by this amount over the next few years, while costing you big bucks in property tax, insurance, maintenance and the lost investing power of all that equity. If you own real estate, you’re better off ignoring a 3% mortgage and using any extra money to stuff into a TFSA, where this kind of portfolio can build what we all need most, besides a hug, – liquid wealth.

And what about the debate over putting long-term money into a tax-free account, or an RRSP?

There shouldn’t be one. RRSPs are fine for tax-shifting, like financing a mat leave, income-splitting between spouses or going back to school to become a realtor, but not for retirement. Yes, you get a tax deduction for making a contribution, but that could easily be wiped away by higher personal taxes in the decades to come. Besides, you must have a powerful reason to take after-tax money and make it taxable again by stuffing it in an RRSP. When you can achieve the same taxless growth inside a TFSA, and pay nothing on the way out, why wouldn’t you?

A tiny percentage of people get this. But 70% own a house.

Imagine that.

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avatarGarth Turner - The Greater Fool posted Sunday, January 20th, 2013.

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