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The case for a 'TFSA-first' strategy in retirement planning

The more we get to know TFSAs, the more they demand attention as a vehicle for retirement saving.

Tax-free savings accounts were introduced in 2009, which means we're still learning how to make the best use of them through a lifetime. Certainly, TFSAs have emerged as a great tool for investing and saving for things such as house down payments. But there's an emerging view that they are also excellent as a primary way to save for retirement. Better, arguably, than registered retirement savings plans.

Fresh evidence of TFSA superiority comes in a report published by the Canadian Institute of Actuaries and the Society of Actuaries. The report was aimed at employers who offer retirement plans for their employees, but there are implications for individuals wondering whether TFSAs or RRSPs are the most effective retirement savings vehicles.

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To sum up, TFSAs are almost a no-brainer choice over RRSPs for the young adults of Generation Y. They can also make sense for people who are as close as 10 years from retirement. "They should certainly be giving serious consideration to a TFSA-first strategy," says Doug Chandler, the Calgary-based actuary who wrote the report.

Mr. Chandler says the conventional wisdom is that RRSPs and registered pensions are ideal retirement savings vehicles because people generally pay a lower tax rate in retirement than they do while in the work force. Net result: The tax deduction you get for making an RRSP or pension contribution is bigger than the tax hit on RRSP withdrawals or pension payments in retirement.

The flaw in this argument is failing to consider how clawbacks of government programs affect the income of people in retirement. Clawbacks aren't a tax, per se, but they have the same impact in reducing disposable income. On a federal basis, the Guaranteed Income Supplement, Old Age Security, the age amount tax credit and the goods and services tax credit are examples of programs that are clawed back to varying extents as your income rises.

Want to avoid those clawbacks? Draw retirement income from a TFSA instead of an RRSP. You contribute to TFSAs with after-tax dollars, which means the money you pull out of them is of no interest to the Canada Revenue Agency. This means no tax on your withdrawals from a TFSA, and no chance that a clawback will be triggered by this income. Mr. Chandler says that by using TFSAs only, you could retire with no other taxable income than your Canada Pension Plan payments, OAS and GIS.

Another reason for the emphasis on RRSPs and registered pensions is that they're designated for retirement and not easily accessible to people who need cash in the short term. Money can be withdrawn from an RRSP, but there's paperwork involved and withholding taxes and withdrawal fees to be paid. Money in a registered pension is for retirement income only.

TFSAs are wide open by comparison. If you want money in your TFSA, you can often go online and transfer it right into your chequing account. Behaviourally speaking, this is vulnerability. Practically speaking, it's strength for the many members of Gen Y who work in the "gig economy," a term that means working on temporary jobs or contracts and then moving on.

Mr. Chandler says it makes sense for these millennials to think more in terms of general economic security than more narrowly at retirement. They need a fund that can help them cover costs between jobs as well as when they retire. TFSAs accomplish this a lot better than RRSPs and registered pension plans. Another TFSA benefit is that you can recontribute money you withdraw (wait until the next calendar year to do it); you can't do this with RRSP withdrawals.

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Some employers are already offering group TFSAs to their staff. Mr. Chandler's work suggests that more of these plans would be a positive development for young workers who want financial security in the near, medium and long term. As for older people, he figures you can go with TFSAs if you've been using these accounts since they were introduced and have at least 10 years until retirement. That's long enough to build enough assets in a TFSA to provide meaningful retirement income.

High earners have the easiest job in considering RRSPs and TFSAs, Mr. Chandler says. "If you're high-income, you're just going to do everything."

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About the Author
Personal Finance Columnist

Rob Carrick has been writing about personal finance, business and economics for close to 20 years. He joined The Globe and Mail in late 1996 as an investment reporter and has been personal finance columnist since November 1998. Rob's personal finance columns appear in The Globe on Tuesday and Thursday, and his Portfolio Strategy column for investors appears on Saturday. More

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