When Gillian Dalton was introduced to the tax free savings account in 2009, she immediately took advantage of it. Back then interest rates were higher and people could invest only $5,000 in the account, so she stashed some short-term cash in a guaranteed investment certificate. “It was a good way to avoid paying tax on our investments,” the Toronto-based entrepreneur says.
Since then the TFSA has grown by $5,000 every year – the contribution limit was raised to $5,500 a year in 2013 to account for inflation – which means she can now save $25,500 in her account and $31,000 come January. While she has a lot more to work with since she started using the account, Ms. Dalton, who maxes out her contribution every year, is still invested in short-term GICs.
Michael Berton, a Vancouver-based certified financial planner with Assante Financial Management, knows this scenario well. He has many clients who stashed $5,000 away in a GIC that first year and they’ve just kept adding to their low-yielding investments since.
However, that approach isn’t necessarily the best one any more, Mr. Berton says. As contribution room expands, its power as a retirement savings tool grows, too. “The TFSA is starting to matter,” he says. “Now we need to actually look at this and try to make it into a real investment portfolio.”
Most people will continue using their registered retirement savings plans as their main savings vehicle in part because of the tax refund. (Individual contribution room grows by 18 per cent of your income up to a limit of $24,000 this year.)
Depending on how you look at it, one advantage, or disadvantage, of the RRSP is the tax hit you’ll take when you withdraw funds in retirement. This works well for people who contribute while they’re in a high tax bracket – and get a refund at that higher rate – and then withdraw at a lower rate in retirement.
But, with people working longer and with years of savings having been built up, some people will be in the same tax bracket when they contributed as when they pull their savings out.
Allan Small, a senior investment adviser with DMW Securities, says that if someone knows that his tax bracket won’t change after turning 72 – when he’s forced to remove money from a registered retirement income fund – it can make more sense to contribute to a TFSA. “Any tax savings you’re making today will [disappear] because when you pull money out you’ll have to pay tax anyway,” he says. “If you don’t need the tax deduction then the RRSP doesn’t make a lot of sense.”
An RRSP is also less advantageous if you’re young and not making a lot of money. If you invest in the account when your income is low, you’ll be using up room, but you won’t get much of a tax refund. Instead, Mr. Small suggests contributing to a TFSA now. Later, when you making more money, move those investments into an RRSP.
While you could have followed that strategy in 2009, the refund on that money wouldn’t have been much. It’s a different story if you roll $25,000 or more into an RRSP. “There’s a lot more to play with now,” Mr. Small says.
For people nearing retirement, a higher ceiling in the TFSA means you can now more easily avoid the dreaded Old Age Security clawback. If your net income exceeds $70,000, your OAS payments will be taxed 15 per cent on the net income exceeding the threshold amount. You’ll get nothing if your income is more than $114,000. While the amount you can get isn’t enormous – the maximum payout in 2013 is $6,552 – it’s still money that most would like to receive.
Money withdrawn from an RRSP or RRIF is subject to the OAS reduction, but any cash that’s removed from the TFSA is not. Some planners, Mr. Berton says, are now moving money from the RRSP to the TFSA in order to get around the clawback. “We say that from now until 65 we’re not going to save in an RRSP and we’ll use a TFSA and other investments instead,” he says. “That way you can avoid tax jail.”
When it comes to investments, the default doesn’t need to be a GIC any more, unless you still want to use the money for short-term savings. If you have a longer-term time horizon, consider investing in the same way you would with your RRSP. “Things that pay dividends, corporate bonds, preferred shares,” says Mr. Small, rattling off securities with better returns than a GIC.
Some people are now using the TFSA for both short-term and long-term savings. Since you’re not taxed when you withdraw, it does remain a good place to temporarily stash cash. If you are using it for both, be sure to invest each pot according to when you’ll need to use it, Mr. Berton says.
Ms. Dalton, like a lot of Canadians, is only starting to figure out that there’s more to the TFSA than she initially thought. She says that she’s keeping the money in her account for the long term, yet she’s still buying GICs. As she saves more, though, she may have to rethink how she uses the account. “I need to get some advice,” she admits. “The TFSA is one of my main ways to save and I’ll keep using it whatever the investment strategy.”