Tax Free Savings AccountsLiam Hendrikse
Jeez. Has it really been this long? The apology is as overdue as this article; I welcomed my 2nd child just over 9 months ago, and suddenly my focus shifted back to existing on a Leonardo DaVinci-style sleeping pattern of 20 minutes at a time. Those of you with kids, can probably understand the lifestyle; those of you who don't are probably thinking "Kids? No thanks!"
Anyway, I digress.
Funny thing, investing. The markets came back strong, those that invested in March and April of 2009 have huge grins on their faces, and yet on the surface nothing really seems to be better. The big talk now is Rising Interest Rates, the impact of the Harmonized Sales Tax, ecological disasters, bailing out Greece, staging an intervention for la Lohan, and discussing the merits of hosting a Twilight-themed dinner party (utterly ridiculous, in my opinion).
Hmmmmmm....
Ok, let's get down to business. I've been meaning to talk about the Tax Free Savings/Investment Account, and whether it's good, bad or ugly. I think it's pretty great. In a nutshell, each year you can contribute/invest up to $5000 into your plan (this can be any investment vehicle you want). All your income or gains are tax-free, all your withdrawals are tax-free. You pay no tax! And in a world where people are finding it harder to find extra money to invest for the future, in certain circumstances it's the only plan you really need.
But how does it compare, long-term, to existing investment vehicles like the RRSP or, a non-registered investment account? Let's crunch some simple numbers. Assume we invest $5000 in a TFSA, $5000 in an RRSP, $5000 in a non-registered account at Year 1. Every year, each account gains 5% in "Capital Gains". Let's assume we work and make $50,000 a year in salary (apologies to those of you who think that number is ridiculously low! ;) for tax purposes. Which account is better off at the end of 30 years?
TFSA: $5000 x (1+.05)30 = $21609.71
Non-registered: $5000 x (1+.0422125)30 = $17284.56
(*because remember, in a non-registered account you pay tax at your Marginal Tax Rate, so ½ of your gains are "Tax Free" and the other ½ is taxed at your MTR i.e. 5% minus (5% x .3115) = .0422125
RRSP: $5000 x (1+.05)30= $21609.71
Wait. That looks to be the same amount as the TFSA? Well, it is – but there's a difference. When you retire and ultimately start withdrawing that registered money, the Government wants their cut. So, whatever your marginal tax rate at that time, that's how much tax you pay on the amount you withdraw. Even worse, is the fact that when you invest any money in an RRSP, it loses its "identity." So, for a "Capital Gain" you are usually only taxed on ½ of the gain – but with an RRSP, you are taxed 100% even on the initial amount you contribute! A raw deal if I ever saw one. So, let's assume the Marginal Tax Rate is still 31.15%:
You withdraw $21609.71 when you retire after 30 years.
Tax = .3115 x $21609.71 = $6731.42!! So you are left with $14878.29 – on the surface, it's the worst deal of the three.
So how is it a good deal? Well, when you contribute to an RRSP you get a tax deduction – that's the incentive. An individual making $50,000 a year, gets a "refund" of $1557.50
A really good financial plan would take that refund and reinvest it for the remaining 29 years, so:
$1557.50 x (1 + .05)29 = $6410.88
Which puts you close to the TFSA amount. Invest the $1557.50 back into an RRSP and you get a "refund" of about $450, which you then roll back into an RRSP and you can start to see how this proliferates – but ONLY if you are dedicated to your financial plan.
But it's complicated. Most older people I speak to wish that the TFSA had been around when they were younger, as nobody likes their retirement years to be made more complex by crazy tax stuff due to their RRSP/RRIF. Conversely, most younger people I speak to want to know if they can get a TFSA through Twitter (what the heck is that, anyway?)
I have to agree that the TFSA is a nice, simple option. However, talk to your financial advisor about what's best for you, and what your priorities are – you can go over some pretty amazing strategies. The fact is, there is usually room for at least two of those options in your financial plan. These days, Three's Company¹.
Until the next time!
¹This article was not endorsed by Jack, Janet or Chrissy.
Liam Hendrikse is an independent financial advisor, and a model with Sutherland Models. He provides 1st and 2nd opinions on new and existing personal financial plans. He's also a forensic scientist, but that's another story altogether...
email: liam_hendrikse@rogers.com
This is intended as a general source of information only and is not intended to provide any personalized tax, legal or investment advice, and is not intended as a solicitation to purchase securities. Liam Hendrikse is solely responsible for its content.
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