Although more than six million Canadians have opened tax-free savings accounts since their introduction in 2009, there is a pressing need for education about how to maximize the usefulness of these accounts, according to executives at financial services institutions providing TFSAs.
Indeed, some argue that Canadians are too conservative in their investment choices and need better advice on how to combine TFSAs with other savings products, such as RRSPs.
“It’s the fastest-growing segment in our business, and I expect it would be for all the banks,” says David Richardson, vice president, enterprise sales and group financial services, with Toronto-based RBC Global Asset Management Inc. “But we see that only a low percentage of our overall client base is taking advantage of the TFSA. Beyond maximizing contributions, it’s about thinking how to use the product. For many people, it can be a long-term vehicle to maximize the growth potential over time.”
Individual clients can contribute a maximum of $5,000 each tax year to a TFSA and make withdrawals at any time without penalty. Income and capital gains generated in the account are not subject to taxes — and withdrawals are tax-free. The full amount of withdrawals can be put back into these accounts in future years, but replacing the withdrawn amount in the same year may result in an overcontribution penalty.
Yet, the vast majority of Cana-dians are using TFSAs as a short-term parking place for cash. Says Richardson: “The asset mix tends to be quite bit more conservative than you would see in an RRSP.”
At Toronto-based Royal Bank of Canada, the bulk of TFSA investments — 71% — are held in high-interest savings accounts and short-term guaranteed investment certificates. The remaining 29% is held in so-called “long-term products,” ranging from long-term GICs to equities and balanced mutual funds.
This conservative bias might be attributable to clients’ lack of knowledge. A survey of 1,506 Canadians regarding TFSAs, conducted in February 2010 for Toronto-based Mackenzie Financial Corp., found only 44% of respondents answered three or more of the five questions about TFSAs correctly, 28% answered all five incorrectly and just 8% had all the correct answers.
“When it comes to learning the basics, there is still work to be done,” says Wilmot George, Mackenzie’s director of tax and estate planning. “For instance, only 41% know that a broad range of investment options are available for the TFSAs.”
There is nothing wrong with using a TFSA as a short-term savings vehicle and benefit from the product’s tax-sheltering feature. Yet, as Richardson notes, “There are many more people who could use it as a long-term savings vehicle but are not taking advantage of that feature.”
The conservative bias, Richard-son notes, could also be attributable to the fact TFSAs are relatively new: “Think of how long it took RRSPs really to take hold. TFSAs are something that advisors should be talking to all their clients [about].”
Still, the product’s name is misleading, which could be a stumbling block to its wider acceptance. “To call it a ‘savings’ account is a misnomer,” says Patricia Lovett-Reid, senior vice president with Toronto-based TD Waterhouse Canada Inc. “It’s really an investment account.”
Despite the unclear nomenclature, she notes, a wide range of instruments — from high-interest savings accounts and bonds to real estate investments trusts, equity funds and stocks — are eligible for inclusion in a TFSA.
To help your clients maximize the TFSA, you may have to spend more time educating clients that the TFSA is another tool in the arsenal of investing tools.
“You have to factor this into the advice you’re giving the client,” says Richardson, “in terms of whether they need to use the TFSA and how they can use it.”
Yet, too often, clients are faced with an either/or situation between TFSAs and RRSPs, says Lovett-Reid: “[The two] are very different. You have to explain that an RRSP is a tax-deferred, back-end-loaded savings plan compared with a TFSA, which is a front-end-load savings plan because people contribute with after-tax dollars that grow tax-free. You have attributes of both that can be advantageous. But it really depends on an individual’s income, how much he or she is contributing and his or her reasons for saving.”
As a result, George says, you have to tailor a TFSA to each client’s objectives: “Is your client using it for short- term needs or long-term needs? That’s the key question, and it will drive what you do with your TFSA.”
For someone with long-term objectives, holding equities in a TFSA is very attractive, George adds, because those investments have the greater potential for tax-free rates of return.
But a TFSA also can be used for short-term needs because accountholders can redeem at any time without penalty.
“So,” says George, “we have to ask the client, ‘Is it your intention to use the TFSA for the short term or the long term? Will you need the money in six months, or a year? Or is the TFSA another retirement vehicle?’ From there, we can define the best strategy.”
George urges advisors to educate clients on the features of TFSAs, such as how to avoid penalties for overcontributions or use direct transfers from one institution to another to avoid overcontribution penalties. IE