The Tax-Free Savings Account (TFSA) is a reality in Canada now that we’re in 2009, and there are some questions that you should have answered before opening a TFSA. Costs of a TFSA can offset its tax advantages.
The TFSA differs from an RRSP in that contributions cannot be deducted from your income. On the plus side, all growth in a TFSA (interest, dividends, capital gains) are tax-free and can be withdrawn tax-free.
Before leaping in and opening a TFSA at your bank, it pays to think of the bank’s motives. Banks are in the business of making money. How will they make money from your TFSA? Here are two big areas:
2. Interest rate spreads on cash and fixed income investments.
The TFSA is new territory for banks. You can bet that they have put considerable effort into deciding the best way to make money from TFSAs. Here are some possible approaches:
1. Offer TFSAs with similar terms and fees as RRSPs.
2. Offer TFSAs with better terms and lower fees than other accounts and try to grab major market share.
3. Try to set a new standard for higher fees and new types of fees.
Not all banks will take the same approach initially. Before opening your account, you should understand what fees you will be charged and what restrictions you will have to live with:
1. Are there fees for making deposits? (Probably not.)
2. Are there fees for making withdrawals? What about if you make many withdrawals in one year?
3. Are there account maintenance fees? (Probably for low balances, but how can the balance be high if we’re limited to a $5000 contribution this year?)
4. What interest rate is paid on cash? Is it lower than for other types of accounts like RRSPs and savings accounts?
5. What rate is paid on fixed-income investments like GICs? Is it lower than the rate paid on GICs outside the TFSA? This is a tricky one to answer because you can almost always negotiate a higher rate than the advertised rate.
6. For self-directed TFSAs, are you restricted to a limited set of investments? If all you’re allowed to buy are high-MER mutual funds, then you will be locked into paying very high fees.
7. Are there fees for transferring assets to another TFSA?
8. Are there fees for closing down a TFSA?
9. Are there any other types of fees that I’m not imaginative enough to think of?
If you’re planning to open a TFSA for emergency cash or a GIC, you can probably get these questions answered to your satisfaction fairly quickly. However, the range of possible new fees for self-directed TFSAs is broader. I plan to wait a while and let others run into the problem areas. Life can be fun on the bleeding edge, but I’d rather watch from a safe distance and avoid the spray.