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The Canadian government introduced a really smart new way for its citizens to save for their future by introducing Tax Free Savings Accounts (TFSA).
These are special accounts that allow your assets to grow sheltered from taxes. You can contribute up to $5000 a year (the limit for 2009) with this limit rising with inflation in $500 increments. As well, any unused contribution limits can be carried forward. So let’s say that you don’t contribute for 5 years and then receive an inheritance of $25,000. You would be able to put that lump sum and have it grow tax free. But any contribution over the $5000 a year limit gets a 1% a month penalty (similar to Registered Retirement Savings Plans).
Unlike RRSPs, you don’t need to have any income to make contributions to a TFSA account. But neither will you receive any tax benefit for simply making such a contribution.
The really amazing thing is that you can also withdraw the money at any time with no tax consequences! So unlike a RESP or RRSP your money is not locked in. And since contribution limits are carried forward, when you make a withdrawal, you have increased the contribution amount for future years by the same amount.
But the real flexibility of this new account is that it can hold bonds, GICs, mutual funds, equities and equity options. So if you combine it with a brokerage account that would allow you to trade the account, you have the best of both worlds: a trading account which grows tax free!
Although I still like and recommend Interactive Brokers to active traders and even lackadaisical long term investors, for some reason, they refuse to offer registered plans (RRSPs, RESPs, or TFSAs).
Knowing Interactive Brokers’ penchant for thrift, it probably has to do with the cost and human labor involved with setting up and administering such accounts. So with Interactive Brokers out of the picture, Canadians who want to open up a TFSA are left with the usual options of the big banks as well as a few independent brokers.
I’ve looked at all the options out there, and for Canadians, the best option for a TFSA is Questrade.
If you are an IB client like me, something else that you may not have realized is that buried within the agreement you signed with Interactive Brokers, is a clause that says you must have another brokerage or trading account. So if you don’t already have a ‘back up’ account, this is a great way to set one up. Not only will you be earning tax free capital gains, dividends, interest, etc. but you will also be saving money by paying the lowest commission rate in Canada (second to IB).
For equities, Questrade charges 1 cent a share, with a minimum of $4.95 and a maximum of $9.95 per trade. As well, with a regular Questrade account you can trade options, futures, forex, mutual funds and physical gold.
And on top of all that, as a reader of Trader’s Narrative, if you sign up using the link in the banner, you get $50 in free commissions! What else can you ask for?
With Questrade’s low commission structure and no annual fee, you can quickly transform your tax-free savings account into a tax-free trading account. Just imagine, within a few years of contributions, you can have $25,000+ growing tax free.
Of course, the only disadvantage is that if you have losses in this account, you can’t use them to offset your taxes. So depending on how confident you are in your ability to be profitable in this account, you might want to use this as more of an investment account for high dividend paying stocks, REITs or bonds. But remember, since this is a registered account, you can trade and hold any asset in your Questrade TFSA account except forex and futures. And for the same reason, you can’t use margin - this is a cash account.
Since capital gains are already 50% tax-free, you might want to only include bonds or bond ETFs which would otherwise be taxed at the full amount. Another option is to take advantage of the bear market and buy a leveraged equity ETF to ride the recovery. Whatever your strategy, take the time to learn about this new option or speak with an advisor to find out how it can benefit you.
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