It’s always exciting when the government delivers a tax saving mechanism to Canadians and one of the most recent tax reducers is the Tax Free Savings Account (TFSA).
Thousands of Canadians have opened these accounts over the past two years and many of them are making a tactical mistake by doing so. How can saving tax on investment income be a bad thing? It is when the alternative would grow your net worth faster.
The majority of TFSA accounts have been invested in low interest savings account vehicles. Many TFSA investors also still have debt on the books at rates that exceed their TFSA savings rates.
Here is how the math works:
$5,000 TFSA savings account earns 1% ($50).
$5,000 deposited against a mortgage or line of credit at 2.5%. This results in interest savings of $125.
I don’t know about you, but at my house $125 beats $50 every time. Unless…. and there is always an unless.
Unless you may have a short-term need for that $5,000 and the debt that you pay down with those funds is a conventional mortgage that you cannot then draw from in an emergency. Liquidity needs can trump the math.
So, if you can get a guaranteed rate of return on your TFSA investments that exceeds the interest rate on your debt then you are not losing ground. Unfortunately, these days it is very difficult to find guaranteed investments that exceed line of credit and conventional mortgage rates.
The reality is that many Canadians were not asked about their overall financial circumstances when the TFSA was recommended to them, and that is a mistake. We know this happens because we see it all the time.
Thanks to the government for the TFSA account because it’s a wonderful gift. Just be sure that there isn’t a better use for the funds each time you make a deposit.
This information is of a general nature and should not be considered professional advice. Its accuracy or completeness is not guaranteed and Queensbury Strategies Inc. assumes no responsibility or liability.