Tuesday, January 6, 2009

What to Look Out for with TFSAs

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 On the plus side, all growth in a TFSA (interest, dividends, capital gains) are tax-free and can be withdrawn tax-free.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:

1. Fees

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.


  1. Good post, Michael. I took a look at the fees and deals in my post of Dec.10th and found fairly significant differences amongst the banks but not amongst brokerages for self-directed TFSAs. See http://canadianfinancialdiy.blogspot.com/2008/12/fees-and-deals-on-tfsas-at-banks-and.html

  2. CanadianInvestor: Nice spreadsheet! That must have taken a while to compile. As you point out, the transfer out fees are very high. Far too high to justify opening an account for only $5000. The transfer out fees range from 1% to 2.7%. As is often the case, it just isn't worthwhile to open an account unless you put a lot of money into it, or you're confident that you'll be leaving the money there for several years.

    One of the rows of fees is labeled "Swaps". What does this mean?

  3. Swaps are an exchange of shares, for instance in a taxable unregistered account, with cash in the TFSA. It means not having to sell the shares in the taxable account then buying them back in the TFSA. However, if it costs less in sell followed by buy commissions than the swap fee, there is no benefit from a swap.

    Plus no matter what way it would be done, the selling/movement of shares out of the taxable account would trigger(deemed)disposition and capital gains or losses on the income tax return.

  4. CanadianInvestor: Thanks for the explanation. I'm used to calling that an in-kind transfer.

  5. Michael: Why are there separate ages for early contributors to TFSAs? Some provinces are age 18 and some are age 19. Why isn't this just common at age 18 for all provinces. It just seems odd that provinces penalize their TFSA contributors from the most important year from a compounding perspective. Depending on your assumptions, this could be a $50K end-result difference

    1. @Unknown: Here's a quote from a Government of Canada website (https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/tax-free-savings-account/who-open-a-tfsa.html):

      "In certain provinces and territories, the legal age (depends on the age of majority) at which an individual can enter into a contract (which includes opening a TFSA) is 19. In 2009 or later, in these jurisdictions, a person turning 18 years of age who would otherwise be eligible accumulates TFSA contribution room for that year and carries it over to the following year."

      So, the reason for different TFSA start ages is local laws for age of majority. However, TFSA room accumulates from age 18. So, at worst, an 18-year old might miss out on one year of tax-free gains, but could contribute double once he or she turns 19.