It’s time for a secret….as a student making crappy money how did I squirrel away almost $2000 in a year for an emergency fund without noticing the money going? The secret is…there is no secret. Every website, book, TV show etc that you come across will tell you that the Tax Free Savings Account (or TFSA) is Canada’s wonder Account. It works well for short or long term savings and it works even better as a place to stash away your emergency fund.
The TFSA is still fairly new to Canada, having been announced by finance minister Jim Flaherty in 2008 and coming to fruition on January 1, 2009. Now seeing as I graduated in 2007 I can’t really blame the education system for not teaching me about a TFSA they didn’t exist. But I am still going to hold a grudge that at no time, was I taught about emergency funds (maybe we did budgeting in CALM? That class is such a joke) and I know that they didn’t teach me about RRSPs or GICs or any of these types of things. Which is a damn shame too because it would have been very smart for me to open an RSP while I still in high school but that is a topic for another day.
Why is a TFSA better than a regular savings account?
As Gordon Pape states in his book The Ultimate TFSA Guide: Strategies for building a Tax-Free Fortune, Prior to the introduction of the TFSA “There has not been any truly effective way to build an emergency fund. Putting money in a regular savings account is easy and safe but it pays no return to speak of. In fact, when inflation and taxes are factored in, your emergency fund probably loses some value each year” Because this is a designated savings account through the wonders of compounding interest you will make money off of your contributions. For Example, if you put $1000 a year into the TFSA (or $83.33 a month, only $41.66 a paycheque if you’re paid bi-weekly) at a 5% growth rate in ten years you will have $13, 207. So in 10 years you have made an extra $3, 207. Leave that money alone and continue contributing the same amount for 20 years and you will have $34, 719 meaning in twenty years you will have made $14, 719 by doing NOTHING! Why wouldn’t you want to make your money work for you? Gaining money sure sounds a whole lot nicer than paying the bank money in credit card/line of credit interest doesn’t it? But hey….if you want to skip this opportunity and keep buying with credit go ahead. Banks have to make money somehow…how else are they going to pay those of us who are thinking more than 30 seconds into the future.
Why is a TFSA the ultimate place to build an Emergency Fund?
Unlike other forms of investments (in which you may get more return on your contributions) the TFSA doesn’t lock your money in. It is accessible at any time for any reason. Now I would hope that “any reason” isn’t that cute pair of Jimmy Choos or that big screen TV, but technically you could take your money out for those items. It’s no one’s business why you withdraw but yours. Because a true emergency happens without notice or expectation being able to have access to your money is vital to a successful account.
What’s the risk?
As long as you understand your policy there really isn’t one. What do I mean by that? There is a yearly contribution limit, for example (don’t run away….I promise this is easy stuff. Nothing crazy tricky). When TFSA’s were originally introduced there was a $5000 a year contribution limit. As of January 1, 2013 that limit has been raised to $5 500 to allow for inflation. The cool thing is that once you open an account, your contribution room is looked at overall rather than annually. For example. Lets say in 2012 I contributed $1000 but my contribution room was $5000. I have $4000 of space i can still contribute. It rolls over to the next year. so now in 2013 I can actually contribute $9, 500 ($4000 from room leftover in 2012 and $5500 from 2013…keeping in mind there has been a raise for inflation in 2013). You can also replace any money you withdraw as long as you don’t go over your yearly limit. So lets say I contributed $5000 in 2012 and I lost my job. I withdrew $2000. Because I had maxed out my contribution room in 2012 I have to wait to 2013 to replace that money (when the total rolls over). I have attached a related article from the Calgary Harold regarding this to help you better understand what I am trying to say. Bottom line, if you understand your contract the risk is no different than squirreling money away in a “regular savings account” and if you are like me, the thought of contributing $5000 a year is not something that’s going to happen anytime soon anyways. So no worries 🙂
Choices, Choices, Choices
Different banks do have different policies on their TFSAs. They may try and gouge you in administration fees or withdrawal fees. It’s up to you to make sure the bank doesn’t get away with it. Shop around. While opening an account with the bank you deal with for your day to day is easy it may not be the best option so do not be afraid to shop around. You can even shop around, find the best deal and bring it back to your bank to negotiate. Always always remember that banks are businesses, they have their bottom line in mind not yours so don’t let them haggle you into something dumb that doesn’t actually work for you. You can also use your TFSA as an “umbrella” account under which you can open a GIC etc. but remember it is of utmost importance that you always have access to your money so for an emergency fund it is best to just stick with good ol regular savings TFSA.
Below is a youtube video created by scotia to help you understand the role a TFSA can play (they use the term basket where I used the term umbrella)
Here are some comparisions.
Things to look for:
- Does the bank require a minimum contribution per month. BMO for example last I checked requires at least $50/month while, CIBS is $25 and ATB is $25. If you choose one with a minimum contribution ask what happens if you don’t pay it one month
- compare intrest rates….call around and ask. PC is offering 1.4% according to their website, BMO & TD 1.05%, and CIBC 1.15% Try and negotiate a better rate.
How much should you be contributing a month and how the heck are you going to come up with the money? I’m gonna keep you waiting till next week. In the mean time start doing some research on TFSA’s. In a year I have already made just over $500. That’s FREE MONEY!!! Click on the links above…call the 1-800 number…set up appointments. Do what you gotta do. Just make the time. Don’t let your money just sit there and whither away.
- Some Canadians still slow to learn rules of tax-free savings accounts (calgaryherald.com)