The TFSA may be the newer kid on the block among tax-advantaged savings vehicles, but the TFSA is stealing a larger share of the pie than is held by the venerable RRSP.
The Office of the Superintendent of Financial Institutions (OSFI) recently reported that 7.9 million Canadians contributed to TFSAs in 2015, representing 30% of Canadian taxpayers. This is a sharp increase from the 4.5 million taxpayers (19%) who contributed to TFSAs in 2009, when they were first introduced.
Six million Canadians contributed to RRSPs in 2015, representing 23% of taxpayers. The RRSP has been around since 1957.
“The TFSA has become more mainstream in the financial planning conversation,” says David Irwin, regional director and certified financial planner with Winnipeg-based Investors Group Inc. In Pickering, Ont. “Canadians like to have options, and the TFSA can be more flexible than the RRSP without some of the RRSP’s punitive measures.”
From 2005 to 2015, the number of taxpayers contributing to RRSPs decreased, according to the OSFI report, while the TFSA has been gathering converts. At the end of 2015, there were a total of 12.7 million TFSA-holders, or 49% of Canadian taxpayers.
Dan Bartolotti, associate portfolio manager with PWL Capital Inc. in Toronto, agrees that the TFSA is more flexible than an RRSP. “You can invest in a TFSA for the long or short term,” he says. “If something comes up and you want to take money out – to buy a car or a house, for example – there are no tax consequences and you can get the contribution room back next year. With an RRSP, the client would pay taxes on the withdrawals and won’t get the room back.”
In addition, investors are becoming more aware of the variety of investments that can be held within TFSAs and the power of tax-free compounded growth.
“More Canadians are realizing the TFSA is not just a savings account; it can be a useful vehicle for wealth accumulation, not just as a parking lot for cash,” Irwin says.
In addition, by understanding RRSPs, Bartolotti says, you can help your clients create effective retirement saving strategies.
For example, the value of the tax deduction a client receives for making an RRSP contribution must be weighed against the anticipated tax bracket in retirement, when taxable withdrawals will be made. A client will gain a tax advantage only if he or she is in a lower tax bracket when withdrawals are made in retirement.
However, being in a lower tax bracket in retirement than when an RRSP contribution is made is not a foregone conclusion. If the client is not, the immediate tax deduction of contributing to an RRSP will be negated later on, when the money is withdrawn and income taxes are paid at a higher rate.
Young people in a low tax bracket could be in the same tax bracket, or a higher one, in retirement. Young clients or other clients with a moderate or low income – less than $50,000, for example – can focus on maximizing the $5,500 available each year for a TFSA contribution before contemplating a contribution to an RRSP, he says.
Meanwhile, the client’s unused contribution room in an RRSP will accumulate and the client could take advantage of that room later in life by making RRSP contributions when income is higher and the client is in a higher tax bracket.
“A young person, or a person with a modest income, also may not have the means to contribute to both an RRSP and a TFSA,” Bartolotti says. “For someone earning a high income, the larger allowable contributions of an RRSP and tax deductibility make the RRSP a better vehicle. If you’re in a low tax bracket, using the TFSA is best; if you’re in a high bracket, use the RRSP.”
Bartolotti suggests the RRSP’s usefulness can be maximized if clients invest their tax refunds for something productive, such as a TFSA contribution or a mortgage payment.
OSFI’s report states that RRSP usage has been steady for Canadians over the age of 55, while usage by younger people has declined. By contrast, between 2009 and 2015, the percentage of taxpayers contributing to TFSAs rose: to 20% from 9% for those younger than 25; to 33% from 15% for those in the 25 to 34 age group; and to 36% from 26% for those aged 65 and over.
When comparing low- to high-income earners, the report states, RRSP usage increased from 2005 to 2015 only for taxpayers earning between $60,000 and $80,000 a year; usage declined in every other income bracket. Even for relatively high earners with an annual income of more than $80,000, the proportion of taxpayers making an RRSP contribution dropped to 59% in 2015 from 71% in 2005. By contrast, TFSA usage has increased since 2009 for taxpayers at all income levels.
One of the big attractions of TFSAs is that any amount of money can be taken out at any time for any reason, and this flexibility appeals to all age groups. For self-employed people or others with fluctuating incomes, money can be invested in a TFSA in profitable years and withdrawn without penalty in scarcer times.
As TFSAs have no effect on taxable income when withdrawals are made, withdrawals won’t trigger any clawback of income-sensitive government benefits such as old-age security or the guaranteed income supplement. This is an important difference compared with RRSPs, from which withdrawals are added to annual income and can impair government benefits.
Although withdrawal strategies for an RRSP must be commenced when the accountholder is 71, there’s no requirements for cashing out a TFSA. Taxpayers can contribute to their TFSAs and take advantage of tax-free compounding of returns indefinitely.
Read IE’s Special Report on Retirement 2017 to learn more about keeping clients calm, downsizing the family home, getting the most from spousal RRSPs and much more.
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