Every year about this time, people’s thoughts turn to the same nagging question. Should I pay down the mortgage or contribute to an RRSP?

This year there’s a new claim on your savings, the tax-free savings account or TFSA. Starting Jan. 1, Canadians aged 18 and older can contribute up to $5,000 a year to an account in which income – whether from interest, dividends or capital gains – can grow tax free. TFSAs are being lauded by financial institutions, and some financial advisers, as the most important tax break since RRSPs, regardless of your age or circumstances.

Others are more reserved in their assessment. “I’m pop-eyed by the hype,” says Warren Baldwin, regional vice-president of T.E. Wealth in Toronto, who figures the potential savings don’t merit all the attention. “The amount is so small in the grand scheme of things.” Still, anything that might save taxes is worth a look. Here are 10 things you should know about TFSAs.

WHAT IS ELIGIBLE

 

Pretty much anything you can put in an RRSP, you can also put in a TFSA – cash, guaranteed investment certificates, term deposits, mutual funds, income trust units, REIT units, stocks and bonds. However, stocks and stock mutual funds might be better held in a non-registered account because capital losses cannot be used to offset capital gains in a TFSA.

HOW MUCH YOU CAN CONTRIBUTE

 

Each person is allowed to contribute $5,000 a year indefinitely, regardless of age, $10,000 a year for a couple. This is much less than for RRSPs, where contributions are 18 per cent of earned income to a maximum of $20,000 for 2008. The government will keep track of your contributions and withdrawals when you file your income tax form each year, indicating the amount of unused TFSA room. Unused contribution room can be carried forward indefinitely.

If you contribute more than the allowable amount in a year, you will pay a penalty of 1 per cent a month on the excess contributions.

WHAT YOU CAN USE THEM FOR

 

Anything you want. You can save for a house, buy a car, start a business – even take a trip. Best of all, when you withdraw money to spend, the government adds that amount to your next year’s contribution room.

TAX TREATMENT

 

Contributions to TFSAs are not deductible from taxable income so there is no upfront tax break. The break comes later, when you cash them in tax free. In the meantime, money earned on your contributions, whether interest, dividends or capital gains, can grow tax free.

RETIRED PEOPLE STAND TO GAIN

 

With TFSAs, there is no point at which you have to stop contributing and start withdrawing.

TFSAs help shield retired people with modest savings from having government benefits such as the Old Age Supplement or the Guaranteed Income Supplement clawed back because of RRIF withdrawals or annuity income.

Low-income Canadians have been discouraged from investing in RRSPs because they might get 25 per cent back in taxes when they contribute only to end up losing 75 per cent of their public pension benefits to the clawback.

Neither income earned in a TFSA nor money withdrawn will affect a person’s eligibility for federal income-tested benefits and credits, including the age credit and the child tax credit.

As well, retired people, depending on their tax bracket and other circumstances, may be able to save taxes on income earned by shifting some money from other investment accounts, such as registered retirement income funds or RRIFs, to TFSAs.

People who do so still will have to pay taxes on RRIF withdrawals, but they will be able to put the money withdrawn into a TFSA, where future investment income will be housed free of tax even when it is withdrawn.

INCOME SPLITTING

 

TFSAs can help couples and families lower their tax bill through income splitting because a higher income spouse can contribute to a TFSA for a lower income or stay-at-home spouse without the income being attributed back to the higher income taxpayer. As well, TFSA assets can be transferred to a spouse upon death, although the details of this are still being worked out.

BORROWING TO INVEST

 

If you borrow to invest in a TFSA, the interest on the loan will not be tax deductible. Unlike RRSPs, though, the assets in a TFSA can be used as security for a loan. Rather than borrowing, advisers suggest contributing to an RRSP and depositing your tax refund in a TFSA.

WHERE YOU CAN GET THEM

 

At banks, trust companies, credit unions and investment dealers. Discount broker Questrade, for example, offers what it calls a tax-free trading account, with no fee and a $1,000 minimum.

HOW MUCH YOU  STAND TO SAVE

 

Very little, Mr. Baldwin says, especially if you opt for the savings account-type TFSAs many financial institutions are offering. At the 2 per cent or so a savings account pays, you will earn $100 on your $5,000 deposit, he notes. At the top marginal tax bracket, you will save $46. “That’s minuscule.”

Remember, too, that most financial institutions will charge an administration fee, which will eat into your returns.

WHAT THEY’RE GOOD FOR

 

TFSAs are certainly better than RRSPs for a rainy day fund because you can withdraw the money tax free in an emergency. In a year or two, though, you will probably have all the emergency money you need.

For younger people with a long time horizon, TFSAs may be a good complement to RRSPs because they are another way of sheltering income – provided the money is invested in a balanced portfolio and not left to languish in a low-yielding savings account. And they may benefit retired people by helping them avoid the clawback of their pension benefits. The key is how they fit in with your financial plan.

“They require some thinking,” Mr. Baldwin cautions. “Our fundamental position is they have to be properly structured as part of a portfolio. They have to be integrated into an overall financial plan.”

DEREK DeCLOET

 Globe and Mail

In the beginning, there was a Nasdaq bubble. When the air went rushing out of it, a housing bubble formed, a symptom of a much larger bubble in credit, which in turn helped inflate (arguably) new bubbles in the emerging markets, in oil, and in other commodities.

Pop, pop, pop, pop. Can there possibly be any bubbles left after Meltdown 2008? Only one, maybe: Government debt. In 2009, it could be swept away, too.

“The bond market’s going to collapse,” warns Peter Schiff, president of Euro Pacific Capital, a brokerage firm based in Connecticut. He’s one of a small number of financial pros who called the plunge in U.S. real estate prices before it happened; now he’s forecasting the same for U.S. Treasuries. “It’s the biggest bubble yet to burst. It is a complete fantasy.”

That’s the sort of cheery New Year’s forecast you might expect from a man nicknamed Dr. Doom. But Mr. Schiff has important company in the bearish camp. Pimco, the Newport Beach, Calif., giant that manages some $800-billion (U.S.) in bonds, has also grown negative on U.S. government debt, especially long-term debt. With 30-year Treasuries yielding barely 3 per cent, the rewards hardly seem worth the risk, Pimco’s managers are saying – unless you believe U.S. inflation will be close to nil over the next three decades. Not too likely.

In Canada, the bond bargain is not much better. Yes, this country is in superior financial shape. While the Bush Republicans were adding nearly $5-trillion to the U.S. federal debt, Ottawa was accumulating surpluses. Canada’s ratio of net debt to GDP is now about half of America’s – the lowest, in fact, in the G7. It’s hard to believe for those who recall The Wall Street Journal’s 1995 slur making Canada an “honorary member of the Third World,” but for the first time, a triple-A credit rating fits Canada better than the U.S. All of which is nice, but not what really matters to the saver and investor.

What matters is price. A Canadian buyer of 10-year federal debt today accepts a return on his money, before inflation, of 2.88 per cent (down from about 4 per cent at the time of the last federal budget in February). That is to say, he’s making a bet that inflation will be substantially below 2.88 per cent between now and 2019.

What are the odds of that? Assume, given the low risk of a crisis in government finance in Canada, you’d be content to earn a 2-per-cent real return (i.e., after inflation). It’s not much, but at least safe, right?

To get that, inflation would have to be less than 0.89 per cent a year over the next decade. But since the end of the Second World War, this has never happened. The closest was in the 1950s, a rare period of growth with extremely stable prices: from 1951 through ‘61, inflation averaged just 0.94 per cent annually. (Before that, you have to go back to the Great Depression, when deflation ruled.) Not only that, the Bank of Canada’s goal is inflation of at least 1 per cent.

At least the central bank has an explicit upper limit of 3 per cent. The U.S. Federal Reserve does not, and through history it has been every bit as willing to debase the currency in the name of economic growth as has Canada’s central bank. Over the past 60 years, the U.S. buck has lost about 89 per cent of its purchasing power. “Even if somebody wants to say we’re going to have low inflation for the next year or two, can anybody really say that [with] this most inflationary monetary policy in the history of this country, that people are going to be able to buy a bond for 30 years and clip a 3-per-cent coupon [and come out ahead]?” Mr. Schiff asks. “Does anybody believe that?”

Well, apparently somebody does, or bond yields never would have fallen this low, this quickly. There are two possibilities. The first is that the collective wisdom of the bond market really does see another prolonged depression, with deflation to accompany it.

The other is that bond prices have been driven up (and yields down) by short-term factors. In other words, most investors can see government bonds are too expensive, given the deteriorating shape of public finances – just as Amazon.com was absurdly priced in 1999 and bungalows in Phoenix were in 2005. But now, as then, they expect they’ll be able to flip them at an even higher price to someone who’s dumber than they are.

“I think what we should know by now is that we can’t put any faith in what happens in the short run. Internet stocks went way up. Does that validate anything? No. They collapsed to zero,” says Mr. Schiff. When it comes to U.S. Treasuries, “nobody is intending to hold to maturity. Everybody thinks they’re going to get out the door in time.” That’s the greater fool theory at work, and it’s the very definition of a bubble. Beware, all those who would seek shelter in supposedly ultra-safe bonds.