Will new tax free savings accounts rival RRSPs?
By: Parminder Parmar, CTV.ca NewsDate: Mon. Feb. 9 2009 2:50 PM ET
When it comes to Ottawa's new Tax Free Savings Accounts (TFSAs), investors shouldn't be confused by their title, say financial planning experts. They're hoping to put out the word that the TFSAs, which went into effect this year, are not your "typical savings accounts."
Peter Merrick, a certified financial planner and the author of an upcoming book on pension planning, says that TFSAs give Canadians looking to save for their retirement new options that - in some instances -- could rival RRSPs in returns over the long run.
Merrick says the TFSAs allow investors more options than just putting their money into a typical savings account at a bank.
"A TFSA would generally be permitted to hold the same investments as a registered retirement savings plan. These could include mutual funds, publicly traded securities, GICs, bonds, and certain shares of small business corporations," Merrick says.
In other words, says Merrick, the TFSAs offer investment opportunities similar to RRSPs, but they don't give investors the immediate immediate tax benefits of RRSPs. He says the new TFSA is an excellent opportunity for investors to build their retirement savings in addition to -- or even in lieu of -- their RRSP contributions. But Merrick is careful to point out there are some clear distinctions between an RRSP and the TFSA that investors need to know before deciding which option is best.
He says the key differences between an RRSP and the TFSA are:
- TFSA contributions are not tax deductible, while RRSPs offer immediate tax benefits.
- The TFSA (after tax) contributions that accumulate within the account are not taxed upon withdrawal. RRSPs, on the other hand, are taxed when they're cashed out.
- TFSAs allow clients to grow their investments tax-free -- including interest, dividends and capital gains.
- There is no age maximum for an owner of a TFSA to contribute or withdraw funds from the program, unlike RRSPs which cut off an individual's contributions to his or her plan at 71.
- Starting in 2009, individuals may contribute a maximum of $5,000 into a TFSA each year. Contribution amounts will be indexed beginning in 2010.
- The RRSP contribution limit for the 2008 tax year tops out at $20,000.
"Generally, TFSAs are best if the client expects that their taxable income will be higher on withdrawal than when they made their contributions into the plan," Merrick says.
"RRSPs make more sense for a client when their tax rate is expected to be lower when they start to withdraw funds from the plan - for example, during retirement -- than when they made their contributions and took the tax deduction."
RRSPs are in the 'Canadian DNA'
Lee Anne Davies, the head of advanced retirement strategies at RBC, says because TFSAs are so new, one of the biggest challenges for financial advisors this year is just getting the information about the plans to investors.
"RRSPs are in the Canadian DNA," Davies told CTV.ca, quickly adding, "We've got more options this year."
The RBC's 19th annual poll on RRSPs released in December found that:
- Just over half (55 per cent) of Canadians have not heard about the TFSA.
- Sixty-five per cent of respondents between the ages of 18 and 34 are not familiar with TFSAs.
- Among Canadians who are aware of TFSAs, almost half (47 per cent) are planning to open and put money into the account.
- Only eight per cent of Canadians who plan to open a TFSA intend to reduce their RRSP contribution to put money in a TFSA instead.
Davies says investors may not necessarily need to choose between an RRSP and TFSA, noting some could use their RRSP tax savings and put them into a TFSA.
She added that it's important for investors to sit down with a financial planner to figure out their long-term strategies to see how TFSAs and RRSPs fit into their financial picture.
"Figure out what your goals are and know yourself and your own investing style," Davies says.
Generally, a TFSA may be beneficial for investors who may choose or need to remove their money from the account before their retirement. Unlike RRSPs, the TFSA won't have any tax or fee consequences as a result of the withdrawal.
TFSA investors are also allowed to put money that is taken out from the account back into the TFSA in the years ahead, something RRSP investors may not do.
Also, if an investor, for example, does not put money into a TFSA over a five-year period, he or she is -- under the current rules -- allowed in later years to invest the full $25,000 previously left unused.
Merrick says in the long run, a TFSA may make financial sense for many investors thinking about their retirement. He worked out some long term projections about RRSP and TFSA returns for his upcoming book, "The TASK -- The Trusted Advisor's Survival Kit." He charted these projections of pre-tax income (for an individual in the 40 per cent tax bracket) over a twenty-year period:
RRSP / TFSAPre-tax income / $5,000 / $5,000
Tax (40%) / N/A / ($2,000)
Net contribution / $5,000 / $3,000
Growth at 6% (over 20 years) / $16,035.68 / $9,621.41
Tax upon withdrawl / $6,414.27 / $0
Net cash / $9,621.41 / $9,621.41
But Merrick is careful to point out that every client's goals for retirement income -- and their financial needs in the meantime -- will be different. He says that TFSAs provide investors another opportunity to save and grow their money, adding that neither the new savings plans nor RRSPs should be seen as the only investment choices available.