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Retirement planning with TFSAs and seg funds

Investors often ask, ‘RRSP or TFSA?’ But for most Canadians, there’s room for both in their retirement plan


Date: November 16, 2015

She may be a financial expert, but Jennifer Poon says retirement planning can be a challenge, even in her own family.

With all the choices available to advisors and investors, it can be difficult to decide which mix is best, says Ms. Poon, director, advanced planning - wealth, at Sun Life Financial Canada. That’s especially true when it comes to the question of tax-free savings accounts (TFSAs) versus registered retirement savings plans (RRSPs).

“My sister-in-law and her husband are in their mid-20s,” says Ms. Poon. “While her husband works full time as a plumber, she works part-time while pursuing her master’s degree. They both max out on their RRSPs and have no TFSAs. For most people, both TFSAs and RRSPs make sense, but for my sister-law, she should consider her TFSA first.”

There are some situations where an investor may want to prioritize one over the other, points out Ms. Poon.

“For most people who are employed, the deduction that the RRSP contribution provides can translate into significant savings,” Ms. Poon explains. RRSP contributions are not taxed until they are withdrawn, which can usually be done when the individual is no longer working and is in a lower tax bracket.

“Because RRSP withdrawals are taxable, they are generally viewed as more long-term retirement savings, whereas TFSAs [which are not taxable] are sometimes viewed as the additional extra savings we may need to draw on earlier in our lives,” Ms. Poon says.

“For investors in lower tax brackets, the benefits of the RRSP deduction becomes less favourable than someone in the higher tax brackets. In these situations, one may choose the flexibility of TFSA withdrawals over savings in a RRSP.”

While this choice sounds straightforward, it’s now become a bit more complicated, because the upper limits for contributing to a TFSA are likely to change.

The previous federal government raised the annual TFSA contribution limit from $5,500 to $10,000 for 2015; the new Liberal government of Justin Trudeau has pledged to roll the limit back.

“This year’s higher limit may be short-lived,” says Andrea Thompson, senior financial planner at Coleman Wealth, Raymond James Ltd., in Toronto. That shouldn’t really be a factor for most people, she says.

“People shouldn’t ever feel ‘stretched’ to make a certain limit. They should know what their appropriate savings targets are to meet their short-, medium- and long-term financial goals,” says Ms. Thompson. “A good rule of thumb is to be saving 10 per cent of your income for long-term savings.”

The usefulness of any tax-saving program really depends on if people will use it to their best advantage, says Ms. Poon.

Those who are starting a career and expect to earn more later should look toward a TFSA in the early years, leaving room to contribute to their RRSP later when they’ll need the tax shelter.

“I am a saver, and generally speaking, if the money is put in a designated account for a purpose (such as a down payment, college fund or retirement), I find you are less likely to spend it elsewhere,” she says.

Regardless of whether an individual chooses an RRSP, a TFSA or both, investors may also be wondering about the value of investing in segregated (seg) fund products. These are products where the investor pays an insurance fee in return for a guarantee that all or a portion of the principal amount will always be returned on maturity or as a death benefit, no matter whether the investment loses money in the markets.

“A seg fund product can be a very powerful planning tool, but it comes with a price,” says Darren Coleman, senior vice-president and portfolio manager at Coleman Wealth, Raymond James Inc. in Toronto. The price investors pay by choosing seg fund products is high management expense ratios; Mr. Coleman says that price can be worth it for some clients.

“In the 1990s, we had clients who bought seg fund products that were quite aggressive in the tech sector. Then the [2000] tech crash occurred. Investors with seg fund products held onto their portfolios for a long time, hoping for a recovery in that sector that actually took years,” he says.

“They got their [their initial principal] back. It wasn’t fun, but it was better than not getting their money at all,” Mr. Coleman says.

Ms. Poon agrees that seg fund products can be flexible planning tools.

“For baby boomers, they provide the ability to combine guaranteed lifetime income and provide for an estate, which is most attractive,” she says. As an insurance product, the death benefit is paid to the beneficiaries directly, and thus bypassing probate. A seg fund product also provides potential creditor and family law protection.

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