Expected TFSA change is a plus
If the yearly contribution limit is doubled, almost everyone should take advantage of this investment
We’ll find out in a little under two weeks whether Finance Minister Joe Oliver will double the annual tax free savings account limit from $5,500 to $11,000.
It seems likely he will do that in his April 21 budget based on a leaked letter published in the Star Monday. If so, the decision changes the game for Canadians. As we live longer and have a more fractured retirement saving system, it offers another way to sock something away.
Maybe we won’t be able use all the room, but don’t believe the chatter that this would benefit only the “rich.”
I know a lot of people who work hard and have done well.
They aren’t rich, but yes they’ll benefit most, because they make more money. They also contribute most through their taxes to social programs, many of which they don’t get.
Those programs are good, because income equalization makes for a stronger social fabric.
But we all end up with more room to save which is a good idea in an era of record low savings.
Nor is it a given that such a move will drain federal coffers and hurt other programs because so much income will escape the taxman’s grasp. After 50 years of registered retirement savings plans (RRSPs), 94 per cent of the contribution room is unused, says the Canada Revenue Agency (CRA). Some 88 per cent of available TFSA room is available now. And tax laws are rewritten all the time. “Any future government could reverse this,” as Moshe Milevsky, a finance professor at York University and pension expert notes, “Tax laws rarely stay the same for long.”
“Any time you have more savings options that’s a good thing,” says Dan Hallet, a principal with Oakville’s Highview Financial Group.
“You may not be able to use it all, but it’s there.”
So here’s a closer look at the implications:
RRSP versus TFSA: The difference between RRSPs and TFSAs is that with a TFSA you’ve already paid tax on the money you put in it. Anything inside grows tax-free. With an RRSP, you get the tax back now in the form of a refund and pay it later when you withdraw the money in retirement.
If you expect your tax rate to be lower in retirement than it is now, an RRSP makes more sense, says Cindy Crean, managing director of private client services at Sun Life Global Investments. If you think it will be higher, a TFSA is better.
But people make financial decisions for reasons other than tax, she says. These include whether they need the money soon, whether they are saving for something other than retirement, a house say, and how easy is it to get at the funds — the hassle factor.
So when it comes to where to put the money, a bit of both may work.
“There are a lot of ‘what-do-I-dos’ and ‘what-ifs’ in life,” Milevsky says. One what-if is predicting your future tax rate. “Have a bit of both,” he says. “The benefit in having both is that you can fine-tune it like a thermostat.”
If you’re 25+: You probably can’t save $5,500 a year now, so doubling that to $11,000 won’t make much difference for now. But any unused room adds up and the power of compounding works in your favour. The longer you let the money grow, the greater the snowball effect.
The advantage goes to the TFSA because you may need the money for a down payment or to go back to school.
But RRSP versus TFSA is less a worry than getting started.
“If you’re 25, it doesn’t really matter what you invest in,” Hallet says. “Just put the money away. That’s the most important thing. If you’re not as disciplined go for the RRSP because it’s harder to get out.”
If you’re 55+: Older workers have taken to TFSAs in a big way, because it’s something they haven’t had for most of their working life. The finance department says 71 per cent of Canadians maxing out their TFSAs are over 55. The CRA says the age group with the most accounts is over 75.
After age 71, you can’t put anything into an RRSP. A higher limit offers a better place to shelter their money for themselves or their heirs.
For high incomes: The RRSP would be the first choice if you assume your tax rate is higher now than in retirement. But if you have no more RRSP room a higher TFSA limit is a plus. This also goes for those with good pensions. They may not have much RRSP room, so a higher TFSA limit helps.
For low incomes: TFSAs are a better choice than RRSPs because what accumulates in a TFSA does not count as income for tax purposes. That means if you receive the guaranteed income supplement (GIS) money inside a TFSA, it doesn’t count as income, while money taken out of an RRSP does. Low incomes are unlikely to be able to use the extra room, but there may be one-time events — inheritances or other one-time situations where they could and not hurt their entitlement.
If this measure is in the budget it offers a terrific way to save a little more and it can play a role in your retirement planning. But always, one size doesn’t fit all. Your circumstances will decide what you do. Adam Mayers writes about investing and personal finance on Tuesdays and Thursdays. Reach him at amayers@thestar.ca.