Nevada Retirement Planners

Malcolm Hamilton’s take on Tax Free Savings Accounts

This morning the third of four video interviews with retirement expert Malcolm Hamilton was published here.  The first two aired earlier this summer. Hamilton is an actuary and worldwide partner with Mercer's.

This particular segment looks at the Tax Free Savings Account (TFSA) that was announced in the last federal budget. Most of Canada’s financial services industry is working feverishly to get TFSAs ready for the new year. By all accounts, the TFSA could be the biggest boon to the industry since the RRSP.

In March, Hamilton published a long essay on TFSAs, which can be found at the end of the blog post here. In the very long term he is concerned about a future generation of seniors that will live virtually tax free in retirement.

That’s a far cry from the current situation. As he mentions in the interview, today’s seniors frequently cry the blues when they start withdrawing from their Registered Retirement Income Funds (RRIFs). They tend to forget that they got a tax break when they first put money into their RRSPs (which later can be converted to RRIFs, at which point withdrawals are taxed. See yesterday’s entry on CD Howe’s proposal to ease up on the RRIF withdrawal requirements).

In the shorter term, Hamilton describes the TFSA as a “wonderful thing.” He contrasts this to non-registered or taxable investment accounts, which he has in the past termed “the leaky bucket.” He points out that receiving 3% interest in a taxable GIC, then paying 40% tax on it to net 1.8% is essentially “futile” if inflation is running at 2%. “You’re not improving your wealth at all outside a tax shelter. Investing in a tax shelter you at least have a fighting chance.”

Hamilton doubts that ordinary Canadians have enough disposable income to pay off all debts and maximize contributions to the three major tax shelters now available: the RRSP, the TFSA and (for college-bound children), the Registered Education Savings Plan.

Most will have to prioritize. “They have a problem finding savings to start with.”

By contrast, affluent people like executives and surgeons will max out on all three (or the equivalent in Registered Pension Plans) and still have enough additional cash to invest in non-registered accounts. That group still has less tax-sheltered room to build up retirement savings than their equivalents in the United States or the United Kingdom. Even so, with the TFSA and higher RRSP limits, this group is better off than it was ten years ago, Hamilton says.

While superficially similar to Roth IRAs in the United States, Canada’s TFSA is much more flexible and has higher savings limits. The Roth is expressly for retirement saving while the TFSA can be used for different purposes at different stages of life.

Thus, young Canadians for whom retirement savings is not a priority can use the TFSA to accumulate a down payment for their first homes.
 
Hamilton describes how the TFSA may be a useful savings vehicle for low-income Canadians  who used to be discouraged from saving in RRSPs because of the clawback of Old Age Security benefits.  Even so, they still may not have to save anything if they wish to retire at 65 and enjoy the same modest lifestyle they experienced in their working years. Before the TFSA, they might have got 25% in taxes back by contributing to RRSPs but ended up losing 75% to the clawback in old age, a situation he describes as “tragic.”

Hamilton also notes that the TFSA may be useful for seniors who do have large RRIFs. While they still will have to pay taxes on RRIF withdrawals, they will be able to pump the post-tax amounts so withdrawn back into a TFSA ($5,000 per person per year). Once inside the TFSA, future investment income earned by the investments housed there will be free of tax, even when the money is withdrawn from the TFSA.

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Posted in Retirement