TFSAs: What are they for?
Well, I have to hand it to the Republi--oh, I'm sorry, the Conservative Party of Canada. The TFSA announcement has certainly garnered them the right kind of publicity. This budget symbolises a new kind of politics in Canada: dynamic, visionary and, most importantly of all, it puts money back in the pockets of Canadians. I'm sure it will be complete coincidence when an election call soon follows this splash of charismatic legislation.
The greatest feature of this new savings vehicle is how bizarre it is. A tax cut on capital gains wouldn't have been nearly as head-turning, and people would quickly criticise it once they realised how little impact it had on them. This vehicle seems even more confusing than the head-scratching RRSP system. (For instance, did you know that the tax break you get from an RRSP does not yield any more after-tax savings than TFSAs offer, assuming that your tax bracket doesn't change between the time you contribute the money and the time you withdraw it? I sure didn't, but I just proved it to myself in Excel. Remember folks, the tax break you get on an RRSP contribution is a deferral, not a refund. The only tax break you're getting in either plan is on the investment growth.)
Because I'm not an accountant, but I've been worrying at a couple of questions today:
What should people use a TFSA for?
It's clearly a great supplement to your RRSP, assuming you've maxed out those contributions. Good news for the wealthy middle class there. When it comes to retirement savings, I imagine you should max out your RRSP before contributing to your TFSA, because it gives you the opportunity to defer tax on all of your savings until retirement, when you will likely have a lower income tax bracket than you had in your earning years.
Most people don't have maxed out RRSPs, though, and the thornier question is what they should use their TFSAs for. I've done a fair bit of retirement forecasting in Excel (because I'm paranoid and have an unhealthy obsession with the topic), and it seems to me that buiding a comfortable retirement fund is extremely difficult unless you start very young and get the magic of compound interest working for you at least 40 years ahead of time. Most people need to contribute as much as they can possibly afford to their RRSPs because time is no longer on their side.
I would argue that saving for anything but retirement is foolish unless you can prove to yourself that your retirement income will be adequate. When calculating your retirement income needs, remember to account for inflation, increased health costs and the fact that most people tend to spend more when they don't have a job consuming so much of their time. All you'll have on your side is Old Age Security (a small amount), the Guaranteed Income Supplement (an even smaller amount, intended only for the most needy) and your fully taxable RRIF savings.
Bear in mind that the only tax break that TFSAs provide is on investment growth. Effectively, it increases the rate at which you can accrue interest. This benefit doesn't translate into large amounts of money unless you stay invested for long periods of time or unless you are investing gobs of cash. I just don't see how a tax shelter will improve people's lives greatly unless they're either wealthy or saving for retirement.
What will people use a TFSA for?
I worry that people will try using a TFSA as an alternative to an RRSP because, on the surface, they appear to give similar benefits and the TFSA is more flexible. In truth, they do, barring the potential benefit of tax deferral. However, TFSAs have a critical flaw in my view as a retirement savings vehicle: they let you withdraw your money! The most important feature of a retirement savings plan is to start early and stay invested for the long term. Getting a the best interest rate and contributing as much as you can are secondary priorities to that, because they have a smaller impact on the curve of your investment growth. Flexibility sounds great on the surface, but retirement savings are dangerous to mess with. I consider the restrictions in place on RRSPs to be important, if unpleasant.
I've heard it suggested that TFSAs are partly motivated by a desire to get Canadians saving more, because they appear not to be saving enough right now. I find it hard to believe that TFSAs will be the incentive people have been waiting for, given the immediate and seductive benefits of tax deferral that RRSPs provide. However, I suppose it is possible that the inaccessibility of RRSP savings is such a disincentive as to overcome the benefit for some people. Seeing how people use TFSAs might settle this question once and for all.
What I Wish
I wish the Conservatives had used this surplus to target what I consider to be the biggest remaining weakness of our retirement savings policies: people don't start RRSPs early enough, because they never feel that they have enough money. People leverage themselves too much for desirable things like houses and cars, and don't place enough priority on retirement savings when they're young and when it will make the most difference. Poorer citizens simply can't afford to save.
Could we take some of that surplus and use it to help with RRSP contributions, perhaps? I would love to see a programme that contributed some amount to young people's RRSPs, as soon as they turn 18. Government contributions would be off limits for withdrawal. It's a half-baked idea, but if we could accomplish something like that, I think it would greatly improve the state of retirement savings in this country.
The greatest feature of this new savings vehicle is how bizarre it is. A tax cut on capital gains wouldn't have been nearly as head-turning, and people would quickly criticise it once they realised how little impact it had on them. This vehicle seems even more confusing than the head-scratching RRSP system. (For instance, did you know that the tax break you get from an RRSP does not yield any more after-tax savings than TFSAs offer, assuming that your tax bracket doesn't change between the time you contribute the money and the time you withdraw it? I sure didn't, but I just proved it to myself in Excel. Remember folks, the tax break you get on an RRSP contribution is a deferral, not a refund. The only tax break you're getting in either plan is on the investment growth.)
Because I'm not an accountant, but I've been worrying at a couple of questions today:
What should people use a TFSA for?
It's clearly a great supplement to your RRSP, assuming you've maxed out those contributions. Good news for the wealthy middle class there. When it comes to retirement savings, I imagine you should max out your RRSP before contributing to your TFSA, because it gives you the opportunity to defer tax on all of your savings until retirement, when you will likely have a lower income tax bracket than you had in your earning years.
Most people don't have maxed out RRSPs, though, and the thornier question is what they should use their TFSAs for. I've done a fair bit of retirement forecasting in Excel (because I'm paranoid and have an unhealthy obsession with the topic), and it seems to me that buiding a comfortable retirement fund is extremely difficult unless you start very young and get the magic of compound interest working for you at least 40 years ahead of time. Most people need to contribute as much as they can possibly afford to their RRSPs because time is no longer on their side.
I would argue that saving for anything but retirement is foolish unless you can prove to yourself that your retirement income will be adequate. When calculating your retirement income needs, remember to account for inflation, increased health costs and the fact that most people tend to spend more when they don't have a job consuming so much of their time. All you'll have on your side is Old Age Security (a small amount), the Guaranteed Income Supplement (an even smaller amount, intended only for the most needy) and your fully taxable RRIF savings.
Bear in mind that the only tax break that TFSAs provide is on investment growth. Effectively, it increases the rate at which you can accrue interest. This benefit doesn't translate into large amounts of money unless you stay invested for long periods of time or unless you are investing gobs of cash. I just don't see how a tax shelter will improve people's lives greatly unless they're either wealthy or saving for retirement.
What will people use a TFSA for?
I worry that people will try using a TFSA as an alternative to an RRSP because, on the surface, they appear to give similar benefits and the TFSA is more flexible. In truth, they do, barring the potential benefit of tax deferral. However, TFSAs have a critical flaw in my view as a retirement savings vehicle: they let you withdraw your money! The most important feature of a retirement savings plan is to start early and stay invested for the long term. Getting a the best interest rate and contributing as much as you can are secondary priorities to that, because they have a smaller impact on the curve of your investment growth. Flexibility sounds great on the surface, but retirement savings are dangerous to mess with. I consider the restrictions in place on RRSPs to be important, if unpleasant.
I've heard it suggested that TFSAs are partly motivated by a desire to get Canadians saving more, because they appear not to be saving enough right now. I find it hard to believe that TFSAs will be the incentive people have been waiting for, given the immediate and seductive benefits of tax deferral that RRSPs provide. However, I suppose it is possible that the inaccessibility of RRSP savings is such a disincentive as to overcome the benefit for some people. Seeing how people use TFSAs might settle this question once and for all.
What I Wish
I wish the Conservatives had used this surplus to target what I consider to be the biggest remaining weakness of our retirement savings policies: people don't start RRSPs early enough, because they never feel that they have enough money. People leverage themselves too much for desirable things like houses and cars, and don't place enough priority on retirement savings when they're young and when it will make the most difference. Poorer citizens simply can't afford to save.
Could we take some of that surplus and use it to help with RRSP contributions, perhaps? I would love to see a programme that contributed some amount to young people's RRSPs, as soon as they turn 18. Government contributions would be off limits for withdrawal. It's a half-baked idea, but if we could accomplish something like that, I think it would greatly improve the state of retirement savings in this country.