Year-end must-do: Transfer to a better paying TFSA

You can do better than a 1% return.

(Photo: Carl Pendle/Getty)

There is one thing you must do before the year ends. Withdraw the savings from your Tax Free Savings Account this month. Then move the money into a better-paying TFSA in January (this sequence is important for reasons explained below).

Over 90% of Canadians have their TFSAs in savings accounts, most of which are held at the charter banks where they are earning 1% or less a year. That’s a negative return after inflation. You can do better: there are TFSAs that give you a positive rate of return after inflation.

People’s Trust, based in Vancouver, pays 3% on its TFSA. Canadian Financial Direct,  a division of the Canadian Western Bank based in Edmonton, pays 2.55%. Both institutions are covered by the Canada Deposit Insurance Corp. and offer online banking or electronic funds transfers to all Canadians (except for residents of Quebec, in the case of Canadian Financial Direct).

These and other high-interest TFSAs can be found on the comparison chart at Canadian High Interest Savings Bank Accounts. As can be seen, a slew of Manitoban credit unions are next in line, offering 2%. They have online banking and are backed by the Deposit Guarantee Corporation of Manitoba.

You MUST start the transfer in December

But—and this is quite important—you have to withdraw funds from your low-paying TFSA before January 1. Many Canadians think moving money between TFSAs is a simple matter of taking it out of one plan and putting it in another on the same day. Not so! Under TFSA rules, you can only redeposit the funds in the next year unless a monthly penalty is paid. (Note: The plan can also be transferred between financial institutions within the same year without penalty by filling out the required forms, but this requires more paperwork and may take several weeks.)

If you wait to withdraw TFSA funds in 2013, you cannot move them into another TFSA until 2014. If you do it this month, you could be earning higher rates by next month once the new TFSA is set up (which can be done online).  And while transferring the cash over, you can throw in the contribution for 2013, which can be as high as $5,500 due to the recent increase in contribution limits.

High-interest TFSAs make a big difference

It’s hard to beat the high-interest TFSAs (mentioned above) when it comes to earning a virtually risk-free rate of return that beats inflation and taxes. There are a few GICs yielding as much as 3%, but they require locking in a 5-year term. Stocks could also provide a higher return, but then again, they might not: because of their volatility, you never know where your savings will be when it comes time to access them (especially in cases of emergencies or short-term savings goals).

Don’t underestimate the impact of small differences in interest rates over the long term. For example, if you placed $25,000 at a 3% annual interest rate, it would return $9,925 more over the next 15 years than if invested at 1%. Of course, this underestimates the gain when there is daily or monthly compounding of interest rates—as is the case with the above TFSAs.

Interest rates on high-interest savings accounts inside TFSA are not fixed and can be changed according to market conditions.  So there is a risk current rates could drop. But both People’s Trust and Canadian Financial Direct have a history of holding their TFSA rates fixed for long periods of time. People’s Choice has paid 3% for over three years. Canadian Financial Direct paid 3% for over two years, before dropping to 2.55% in November.

The flip side of floating interest rates is their ability to move in line with market rates whenever they trend upward. And an upward trend in market rates would seem to be a distinct possibility at some point given the historic lows in interest rates in 2012.

How can People’s Trust and Canadian Financial Direct offer such high rates? A big reason is that their overhead costs are much lower (much of their business is garnered through online and electronic channels). Also, People’s Trust doesn’t offer as many banking conveniences. For example, 30-days written notice may be required for withdrawals, which might be acceptable to long-term savers but not to those wanting faster access to their funds (they might instead prefer Canadian Financial Direct).