RRSP, RRIF, SRIF, LIF, LRIF, LIRA, RESP, RDSP, SRRSP, RLSP, TFSA. It’s no wonder most Canadians find the world of saving and investing confusing. Now add in CDIC, CUDIC, PEFP, MFDA, IFIC, IROC, RDBA, FSCO, FPSC, CFP, CLU, CHFC, EPC, CHS. In a world ripe with acronyms that mean nothing to so many, who do you turn to for advice? How do you determine what investment or financial security products are going to help you achieve your financial goals?
The advisors at Pankow Financial Solutions believe we have a responsibility to help you see through the clutter of acronyms and financial lingo, and to help increase your financial literacy. We believe we have a responsibility to help educate and inform you about the confusing world of financial planning and investing, and perhaps inspire you to take action to create a better financial future for you and your family.
One financial vehicle that is commonly misunderstood are Tax Free Savings Account or TFSAs.
This initiative received little fanfare when it was announced in the 2008 Federal Budget. While shrewd investors and wise advisors recognized an opportunity, many Canadians regarded this as just another benefit for the wealthy, even though the contribution limits were relatively modest.
Starting in 2009, Canadians aged 18 and over would be able to contribute up to $5,000 annually to their TFSA. Although contributions were not tax deductible, all investment income could grow tax free, and could be withdrawn, again, with no taxes payable.
Furthermore, unused TFSA room would accumulate and could be carried forward to be used in future years. Amounts withdrawn from a TFSA, including monies invested and growth earned, could be reinvested in future years.
Unfortunately, perhaps due to its name, the cautious nature of some investors, or a lack of advice from some financial advisors, too many Canadians have simply been making their annual contributions into a daily interest TFSA for years now. Most of these plans pay the investor an annualized rate of growth of less than 1%. Little growth means little tax saved. Little tax saved means little benefit gained by contributing to a TFSA.
Many people are not aware that a TFSA can invest in a variety of investment assets including GICs, stocks, bonds, mutual funds and segregated funds. Perhaps Canadians would have recognized this as more of an investment vehicle had it been labelled Tax Free Investment Plan.
After increases in the annual contribution amounts, we all now have $75,500 of accumulated TFSA room.
Let’s look at three examples for three different investors contributing $5,000 each to their TFSAs over the past twelve years:
Investor A followed the advice of her advisor and opened her plan in 2009, simply moving $5,000 from her savings account to a daily interest TFSA each year. At the end of 2020, assuming the 1% interest she has earned every year, her total investment of $60,000 has grown to $63,412, for a tax free gain of $3,412.
Investor B takes a cautious approach but utilizes a conservative investment portfolio recommended by his advisor and has earned an average rate of growth of 4% annually since 2009. His portfolio has risen to $75,129 for a gain of $25,129 or 736% greater than investor A.
Investor C is comfortable with more risk in her portfolio and places a larger portion in equity or stock investment funds. She has a longer term outlook and is attempting to accumulate more money for her retirement. Her portfolio averages a rate of growth of 8% annually and grows to $94,855 for a gain of $34,855 or 10X greater than investor A.
Let’s assume each investor continues to invest $5,000 each year for the next decade, meaning they have contributed a total of $110,000 to their TFSA. At the end of 22 years, Investor A has accumulated $122,358, for a gain of $12,358. Investor B has a balance of $171,240 for a gain of $61,240 and Investor C has accumulated $277,284 for a gain of $167,284. Again, all gains are totally tax free at all times.
Although RRSPs remain the primary savings tool for people accumulating money for retirement, TFSAs are the ideal investment vehicle for people who will either be in the same tax bracket in retirement as they are in their working life or wish to be able to enjoy their money in retirement without having to share that joy with the Canada Revenue Agency (CRA).
Although every circumstance is different, we generally recommend people invest in RRSPs to accumulate the money they will need for their basic income needs in retirement, and utilize TFSAs to create the additional tax-free money they will want to get the most out of life. Most of us hate to overpay for anything, and if that trip of a lifetime is going to cost you $20,000 in retirement, you will likely take it if you can simply take the money out of your TFSA. However, if drawing the money from your RRSP means you need to withdraw $30,000 or more so CRA can get its share of $10,000 plus, most people will just stay home.
TFSAs are valuable investment tools, If you have one, congratulations. If it isn’t providing you with a reasonable rate of growth, consider other possibilities. If you have yet to start a TFSA, don’t worry, you likely have $75,500 of unused room that is currently increasing at $6,000 annually. Start small if you must, but take advantage of the power of long-term compound interest. After all, who doesn’t want something that is tax-free?