Thursday, September 18, 2008

Preparing for the TFSA - My GIC Ladder

In January, Canadians will be able to take advantage of a new investment venue, the TFSA (Tax Free Savings Account). Using a TFSA, we will be able to shelter up to $5000 a year, to grow without being subject to Canadian and provincial taxes. Unused contributions will be available in following years, and any money taken out of a TFSA will also be added back to the next year's contribution limit.

Personally, one of the things I plan on using the TFSA for will be my emergency fund. That way, I will no longer pay taxes on the interests received from that money.

Up to now, my emergency fund has been composed of a high-interest savings account, as well as a 1-year GIC ladder, with one step every month. If you are not familiar with the term, a GIC ladder is a number of GICs, each with the same length, but each made a certain lenght of time after the previous so that the all the GICs together cover the length of the ladder.

For example, my 1-year GIC ladder is composed of 12 GICs, each with a 1-year term. One is started in January, a second one in February, March, and so on. Whenever one of the GICs come to its term, the money is reinvested in another 1year GIC.

A ladder is useful to average out the interest rates available on GICs, and also guarantees that some money will flow out every months, should there be an emergency. If a big emergency requires money than 1 month's money, it is always possible to cash out of a GIC before its term, although doing so reduces the interest that will be paid on that money.

As January 2009 approaches, I have decided to stop reinvesting the money coming out of my ladder, so that I can put a bigger chunk of money into my TFSA right at the beginning of the year. Once the money is in the TFSA, I'll start a new GIC ladder in the TFSA.


Grad Student said...

I was wondering for a while if it was better to set up a GIC ladder or to buy income funds. An income fund may swing up and down, but not by a lot and I may withdraw from it anytime as soon as the money has been there for 3 months.

I ended up buying td canadian income fund, I think it has a current yield of 4%. Do you have any thought to share on the subject?

Frog of Finance said...

To me, the two most important characteristics for an emergency fund are capital preservation and fast access to the money.

I use GICs because they are easy to set up through my ING Direct account. There are certainly other products out there that would meet my needs, but this keep things simple for me.

Which TD income fund to you use precisely? I could not find a "Canadian Income Fund" on the TD site.

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Anonymous said...

Hmm that's quiet interessting but to be honest i have a hard time understanding it... wonder what others have to say..

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