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New contribution limit reopens the RRSP vs. TFSA debate

Financial advisors now need to rethink how best to use the TFSA.


Date: June 25,2015

Financial planning has just gotten a little more complicated.

On April 21, the federal government announced that it was increasing the annual contribution room for the tax-free savings account (TFSA) by $4,500.

While that’s good news for savers and investors – Canadians can now contribute up to $10,000 a year to their TFSA – it also means that there are many more ways this after-tax savings account can be used.

It reignites the RRSP versus TFSA debate, too. While high-earning investors can still save more in their RRSP (the RRSP contribution limit for 2015, not counting unused contribution room from previous years, is $24,390), people will have to think harder about where to save their money.

One thing to consider is whether your tax rate will be higher or lower in retirement, or roughly the same as during your earning years, says Peter Bowen, vice-president of tax research and solutions at Fidelity Investments Canada.

If it will be higher or the same then the tax benefits to using an RRSP aren’t as attractive.

“If you’re not expecting your tax rate to come down in retirement, then you may want to use a TFSA,” he says. “This is especially applicable to younger and mid-income Canadians.”

The increased contribution room should offer greater incentive for those who haven’t considered contributing to the TFSA, says Susan Stefura, a certified financial planner with Bespoke Financial Consulting Inc., in Toronto.

She points out that Canadians who have never used a TFSA before can now make a contribution of $41,000. Those who have only made partial contributions and don’t have the cash to make an additional contribution can carry that extra $4,500 forward indefinitely.

Other than the contribution limit, there has been no change to the list of qualified investments that you can hold within a TFSA. Canadians can still invest in GICs, stocks, bonds, mutual funds, ETFs and cash, and they can withdraw from their tax-free savings account at any time and for any reason, with no tax consequences.

With that in mind, the TFSA is still an attractive vehicle for those saving for a wedding, a home or a new car, as they can use the room to build up cash for a down payment.

And now, in certain cases, it might even make sense to pull some money out of an RRSP and put it into a TFSA, says Mr. Bowen.

“It’s a viable strategy, say, for someone who has retired early, doesn’t have a lot of taxable income during the first year or more of retirement, isn’t getting CPP or OAS yet and hasn’t converted the RRSP to a RRIF,” he says.

“Take the money out of the RRSP now while it’s subject to low taxes, and put the after-tax amount into a TFSA. Then, when the individual’s tax rate has moved back up, the RRIF doesn’t generate as much taxable income.”

This is especially advantageous for individuals who will be subject to the OAS clawback, adds Mr. Bowen.

There have been some complaints that the new TFSA annual limit only benefits wealthy Canadians, but Ms. Stefura says that the increase is good for clients of all ages and incomes.

“About 60 per cent of individuals contributing the maximum amount to their TFSAs in 2013 had annual incomes of less than $60,000,” she notes. “Clearly, the TFSA is a popular savings vehicle for all Canadians.”

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