Million Dollar Journey

1. 1. George

   I’m also excited about the TFSA - it has the double benefit of providing a realistic retirement savings vehicle for low-income earners, and a way for middle- and high-income earners to shield a portion of their investment income from taxation.

   As with most plans of this type, however, the main problem is the possibility that few people will take advantage of it. I know that as soon as I can open a TFSA, I’ll be moving as much of our investment and savings income into it as possible. If a TFSA becomes reality, there shouldn’t be any need for the majority of Canadians to hold any cash in taxable accounts.

   Of course, one thing that has been forgotten in all the discussion of the budget is that it hasn’t been made law yet - a lot depends on whether the vote on this budget results in an election, and the results of that election… Sure, all indications are that the budget will pass, but let’s not count our chickens until they hatch.

   Feb 27th, 2008 @ 8:58 am

2. 2. Ericfromcowtown

   Right now I have a “rainy day fund,” composed of 6-months take-home income, in a money market fund. Yes, I am a bit conservative. As it stands, I am making several hundred dollars of interest every year that are taxable. This new vehicle sounds like a good replacement for my taxable “rainy day fund.” The $5000 / year limit will mean that transferring my “rainy day fund” into a TFSA will be a multi-year process, right?

   Feb 27th, 2008 @ 10:15 am

3. 3. FrugalTrader

   Eric, yes, the $5k contribution limit is a bit low, but it’s supposed to be indexed for inflation. If you have a spouse, you can contribute up to $10k. As far as i know, there are no attribution rules.

   Feb 27th, 2008 @ 10:20 am

4. 4. FourPillars

   I don’t see the income splitting component of the TFSA.

   If you put the money into a spousal TFSA and they withdraw it then you haven’t saved any taxes because the taxes have already been paid. Where is the split?

   Mike

   Feb 27th, 2008 @ 10:22 am

5. 5. The Reverend

   Assuming this TFSA cannot be combined with the SM, doesn’t it actually make the SM less appealing (relatively speaking)?

   A simplification of SM’s return is that you borrow to invest in non-reg funds, thereby making the interest tax deductible, but investment gains are also taxed, so:

   total return = (invest_return - interest) x tax_rate
   assuming all returns taxed equally (gross oversimplification)

   now with TFSA, if you borrow to invest, the interest isn’t deductible, but neither are the gains, so:

   total return = (invest_return - interest)

   obviously the cap on the contribution room is a major limiting factor as well.

   Feb 27th, 2008 @ 10:37 am

6. 6. FrugalTrader

   FP, I think the real advantage here is that the TFSA is a useful “today” tool. For example, the higher income spouse can put money in the lower income spouses TFSA which is then used to invest in higher distribution investments. The lower income spouse can now withdraw the distributions to supplement income without being attributed back to the high income spouse or being taxed on them him/herself..

   Personally, I think the TFSA is a great tool to supplement income “TODAY”, where the RRSP is a great tool for “tomorrow”.

   Reverend, Yes, you are right in that non-registered portfolios are much less appealing with the introduction of the TFSA. The SM does have it’s advantages for those in higher tax brackets as the tax refund will still be higher than the tax on dividend distributions. Perhaps the ideal SM is to invest in long term investments that pay little or no distributions like index funds/etf’s.

   Feb 27th, 2008 @ 10:59 am

7. 7. Sebastian

   Is it a sure thing that you can invest money then channel the returns into this account and it be tax free?

   Feb 27th, 2008 @ 11:30 am

8. 8. squawkfox

   The idea of the TFSA really excites me. I’ve read a few arguments against it around the blogosphere regarding “it’s only 5K.” Thinking ahead in 5 years though…between my spouse and I that’s 50K! I think that’s pretty darn good. ;)

   Feb 27th, 2008 @ 11:31 am

9. 9. Canadian Dream

   Squawfox,

   I agree. Most people don’t get it’s going to a huge thing to have tax free compounding interest which you can pull out for anything at anytime without tax issues!

   I’m going to love TFSA’s.

   Tim

   Feb 27th, 2008 @ 11:36 am

10. 10. The Reverend

    A simple analysis on http://www.taxtips.ca suggests that if used for retirement savings, the TFSA will out perform RRSPs.

    I haven’t run any of the numbers myself yet to verify but it has interesting implications depending on your current tax bracket and expected tax bracket in retirement.

    http://www.taxtips.ca/federalbudget/budget2008.htm

    Feb 27th, 2008 @ 12:16 pm

11. 11. Canadian Capitalist

    Thanks for the link FT. As you can guess, I’m excited about this new account.

    Feb 27th, 2008 @ 12:33 pm

12. 12. FrugalTrader

    Reverend, Yes, I can see the RRSP camp winning for those currently in the highest tax bracket and expect to be in a couple brackets lower during retirement. However, for the middle of the road group, I can see many advantages of the TFSA. That is, providing that people have the discipline to keep the money within the account to compound.

    Feb 27th, 2008 @ 12:33 pm

13. 13. FourPillars

    FT - I agree that this account is a great tax saving tool for “right now”. In the case where you need to save and then spend the money while you are still working then this is the way to do it.

    I’ll be doing my TFSA post tomorrow.

    Rev - I’d like to see the spreadsheet and assumptions they used - I really don’t see how it’s possible for the TFSA to outperform the rrsp assuming the refunds are reinvested or the contributions are made from gross pay.

    Mike

    Feb 27th, 2008 @ 12:33 pm

14. 14. The Reverend

    Its possible because the withdrawals from RRSP are taxed.

    For great simplicity, assume 40% tax bracket today, 30% tax bracket in retirement. Contribute $1 today to TFSA vs $1.4 to RRSP.

    The illustration used would allow to grow for 25 years at 8% and then remove everything in retirement and compare.

    $1 x 1.08^25 = $6.85 in retirement
    $1.4 x 1.08^25 x (1-30%) = $6.71 in retirement

    The outperformance of the TFSA is a result of 40% x $1.00 < 30% x $1.40 = 42% x $1.00

    The problem with this illustration is that, as far as I know (and there’s a lot I don’t), your retirement income isn’t taxed entirely at your marginal rate, but at your average tax rate. So even if you are in the 30% tax bracket in retirement, you are probably paying something like 15% or something on average.

    Feb 27th, 2008 @ 12:42 pm

15. 15. FrugalTrader

    Reverend, it also depends on WHEN you retire. If you’re collecting CPP, or have non-reg portfolio income, then your marginal rate on your RRSP will be affected.

    Speaking of which, if someone retires early and has very little income coming in. It would make sense to withdraw from the RRSP and depositing those funds into a TFSA. That way, you get low taxation on the RRSP withdrawal, along with tax free compound growth/withdrawals for the rest of your days. This might help in reducing that RRIF mandatory withdrawal schedule later in life.

    Feb 27th, 2008 @ 1:09 pm

16. 16. nobleea

    Reverend, you’re right. In order to have a 30% average tax rate in retirement, you’d be pulling out some decent coin. I guess it depends on what you expect your income to be.

    Feb 27th, 2008 @ 1:10 pm

17. 17. Chris Jacobson

    This was the highlight of the budget for me personally.

    Feb 27th, 2008 @ 1:22 pm

18. 18. Nicolas

    The point on US dividend makes me think of a more general question.

    Let’s say you own shares in your TFSA and the value goes up, exceeding your contribution room.

    In other words, is there a difference between the value of the TFSA and the amount of contribution space?

    Nicolas

    Feb 27th, 2008 @ 1:51 pm

19. 19. FrugalTrader

    The rules aren’t set yet, but I would imagine that it would be the same as RRSP’s. That is, your account can exceed your contribution room (without any penalty) as long as it’s from growth.

    Feb 27th, 2008 @ 2:00 pm

20. 20. FourPillars

    Rev - as you point out, using your marginal tax rate to calculate the tax in retirement is very inaccurate unless you have a large pension.

    If you defer taxes on your rrsp contributions at your marginal tax rate and then withdraw at a lower AVERAGE tax rate then you will save on taxes. This can apply even if your marginal tax rate in retirement is higher than in your contributing years. It’s not true that your marginal tax rate has to be lower in retirement than when you contribute to save taxes.

    Mike

    Feb 27th, 2008 @ 2:27 pm

21. 21. The Reverend

    Thanks Mike. That last point is good to keep in mind.

    On a different note, this discussion has gotten me thinking. Its well noted that unless you reinvest your RRSP refund, RRSPs don’t perform any better than leveraged investing.

    My situation is that I use up all my contribution room by deductions from my pay cheque (RRSP and RPP contributions), which in turn lowers the tax withheld. So my refund is essentially buried in my pay every two weeks. If I spend my whole paycheque, I haven’t reinvested the refund. Is anyone else in this boat? Do any of you go back and calculate what portion of your cheque is the refund and then invest it as well? I’d be interested in hearing people’s approach to this. Thanks

    Rev

    Feb 27th, 2008 @ 4:30 pm

22. 22. Commander T

    One problem with the analysis performed by The Reverend is the amount of money contributed to the RRSP.

    If a person contributed $1.40 to their RRSP they would get a deduction worth $1.40*.4 = .56 which would be a total after tax cost of 1.4 - .56 = .84. Therefore the comparison really isn’t fair.

    What would be fair is grossing the $1 contribution to the TFSA by dividing by one minus the marginal tax rate.

    or $1 / (1 - .4) = 1.67

    If this figure is used as in The Reverend’s post then we get:

    TFSP: $1 * 1.08^(25) = $6.85
    RRSP: $1.67 * 1.08^25 * (1-.3) = $8.01

    As you can see the RRSP ends up with a higher after tax value at the end of the day. Basically if the average rate at which you contribute the money is higher then the average rate you withdraw the money then an RRSP will have an advantage however the visa versa is also true for TFSP.

    The neat thing is when you consider that the GIS is only income tested and so theoretically at retirement if a person has a large balance of TFSP they could be withdrawing from it for their consumption and also receive full GIS. this GIS is clawed back at a massive 50% rate and so you most likely are at a higher MARGINAL tax rate at retirement with only TFSP. However because people will often have income larger then the GIS limits the AVERAGE tax rate for withdrawing from an RRSP would be higher then you might think but still lower then the 50% GIS clawback.

    I think that a neat strategy for a large saver would be to contribute to the maximum for both RRSP and TFSP and at the beginning of their retirement withdraw only from their TFSP so that the person is receiving GIS. Once the TFSP is depleted (or when you turn 71) start withdrawing from the RRSP.

    Feb 27th, 2008 @ 4:37 pm

23. 23. The Reverend

    Commander T,

    I think you misinterpretted what I was saying. When I said to invest $1.4 to the RRSP, I meant that to be $1 plus the $0.40 refund.

    However you are correct, in theory, about $1.67 being the correct figure, because:

    $1 RRSP contribution creates $0.4 refund
    $0.4 reinvested in RRSP creates $0.16 refund
    $0.16 reinvested in RRSP creates $0.064 refund
    $0.064 reinvested in RRSP crease $0.0256 refund
    and so on in perpetuity but that’s not quite practical

    i admit my example was purely for illustration and quite simplistic but i think in reality, that’s they way most people would implement reinvesting their refund (if at all).

    Feb 27th, 2008 @ 5:03 pm

24. 24. YC

    Long time reader, first time poster.

    Since the attribution rule does not apply to spousal TFSA, withdrawals are not taxable, and the contribution room is set by a uniform, arbitrary initial cap of 5k indexed to inflation rather than by individual earned income, why don’t they just allow couples to hold a joint account?

    Managing one joint account is so much simpler than two seperate accounts, not to mention less transaction costs incurred, especially if your portfolio is heavy with equities. Perhaps I’m too lazy and cheap, but I would like some simplicity and economies of scale.

    Feb 27th, 2008 @ 5:06 pm

25. 25. FourPillars

    Rev - you’re right that you need to reinvest the tax refund for the rrsp to be effective. Really what you should do is contribute from your gross pay - some companies allow this for group rrsps or you can fill out a form from the gov’t which reduces the tax at source.

    It sounds like you are in this situation where there is no refund because you aren’t paying the tax when you make the contribution - this is the best situation to be in!

    Mike

    Feb 27th, 2008 @ 5:26 pm

26. 26. The Reverend

    Mike,

    That is exactly the situation I’m in, and I agree it’s the best situation with regard to not paying the tax, giving the gov an interest free loan, and then getting the refund at the end of the year.

    My dilemma is that the “refund” is essentially buried into my net pay semi-monthly. As always, an example works best.

    Assume I make 30,000 and will make a $3,000 RRSP contribution. Also assume uniform 20% tax bracket and no other payroll deductions

    Option 1, make RRSP contribution with after tax dollars:
    Net semi-monthly pay = 30,000 / 24 * 0.8 = 1,000
    Net pay = 24,000
    End of year RRSP contribution = $3,000
    Refund = $600
    Pay - contribution + refund = $21,600

    Option 2, make contribution at source:
    Net semi-monthly pay = (30,000 - 3,000) / 24 * 0.8 = 900
    Net pay = $21,600
    Refund = $0

    So at the end of the day, i’ve got the same disposible income in either scenario (plus 3k in rrsps). option 1 I gave government an interest free loan. however in option 1, i’m more likely to reinvest the refund of $600 when i get it. In option 2 (my actual situation with diff numbers) i don’t even think about a refund and therefore never reinvest it. but because i had the “disposible” income sooner, i’ve probably spent the $600 refund once tax time comes around.

    anyone else thinking about this? how do you manage it?

    Feb 27th, 2008 @ 6:00 pm

27. 27. FourPillars

    Rev, the problem is that contributing $3000 after tax like in option 1 is not the same as contributing $3000 pre-tax like in option 2.

    The proper comparison is to compare $3000 pre-tax to $2400 after tax.

    I’ll check back in later - have to go home!

    Feb 27th, 2008 @ 6:18 pm

28. 28. The Reverend

    FP,

    I’m pretty sure they are both the same.

    If you’re contributing $X, sure its harder to scrounge up the after-tax dollars to make the contribution than if you made it with pre-tax dollars, but everything else being equal, once you get the refund at the end of the year for making the after-tax contribution, they are exactly equal. You’ve still contributed $X to your RRSP, one way or the other.

    The issue I’m looking for advice on is more of a psychological one in how people manage their contribitions (and particularly the refund) if you make the contributions pre-tax at source.

    Thanks for challenging though. Sometimes I type faster than my brain computes and I don’t always make sense.

    Feb 27th, 2008 @ 8:09 pm

29. 29. mjw2005

    This new savings account is a great idea for working class people with middle/average incomes where RRSPs are not as beneficial and also self employed people who have very low earned income due to deductions but have a few dollars they want to invest…before this new savings program there were no other options for tax free investing other than RRSPs which mainly benefit high Employment Income individuals…

    This new program is great…and I plan to take full advantage of it….

    Feb 27th, 2008 @ 8:18 pm

30. 30. CheapCanuck

    mjw - RRSPs may be of ‘greater’ benefit to high income earners, but low/middle income earners can still benefit from them. I don’t see how TFSAs can beat RRSPs even for a low income earner. Your ‘average’ withdrawal tax rate out of your RRSPs is going to be less in most cases than the tax rate going in, so RRSPs will still win in almost all cases.

    Feb 27th, 2008 @ 8:55 pm

31. 31. George

    I looked at the analysis of TFSA vs. RRSP at taxtips.ca, and the numbers make sense, but not the conclusion. The advantage of the TFSA, assuming quite a bit of compound growth (9% yearly) over a long time (15 years) amounts to an after-tax advantage to the TFSA of $2000. To me, given the amounts of money and time involved, that puts the TFSA and RRSP on even ground as far as retirement savings vehicles goes.

    My plan is to continue maximizing my RRSP, putting a bit of money toward our mortgage, and any remaining money earmarked for savings is going to go toward a TFSA. In addition, our taxable accounts will become TFSAs as well, since a standard, taxable account simply doesn’t make sense if you have TFSA contribution room available.

    $5000 a year isn’t much for people who already have a sizable non-registered portfolio, but for anybody just starting their working careers, $5000 annually is going to be more than enough. Like RRSPs, I think there will be few people maximizing their TFSA contribution.

    Feb 27th, 2008 @ 9:06 pm

32. 32. Marc

    I like the idea of the TFSA, it will be interesting to see the details and figure out how best to use it. It should create all kinds of blog topics over the next little while :)

    Feb 27th, 2008 @ 9:30 pm

33. 33. CheapCanuck

    George - the example at taxtips.ca isn’t computing for me. With the conditions he has stipulated 43.41% MTR (contribution) and 31.15% (withdrawal) the RRSP would be ahead by over $30,000 at the end of 15 years, providing you are putting the tax refund into the RRSP as well.

    Feb 27th, 2008 @ 9:41 pm

34. 34. Four Pillars

    Cheap Canuck - I suspect that the taxtips.ca calculation is not counting the tax refund which doesn’t make sense to me.

    Feb 27th, 2008 @ 11:37 pm

35. 37. Cisco Kid

    Rev,

    I myself find a group RRSP to be one of the most amazing savings vehicles available. Right now I’m putting away RRSPs for my wife for the HBP (Just bought our 1st home) and every 2 weeks I’ve been putting 2K towards spousal RRSPs. That’s just about my normal take-home, so that’s AMAZING in it’s self!!! & I still get a few bucks to take home. I realize I will have a lot less available $$$ for investing once all the new bills start piling in, but without a doubt I’ll be able to do a lot more saving through my group RRSPs. For me the key in saving in this way is to figure out how much you can afford to miss off of your pay & then contribute a good 40% more than that! For me, if I wanted to do the same level of savings without going through the group plan I would have to borrow money at the end of the year & my refund would go right back to the lender anyways ;-) My 2 cents

    Feb 28th, 2008 @ 10:53 am

36. 38. mjw2005

    George - I disagree….maybe you do not have much experience with self-employment and contractors, but as many people who are self employed contractors will tell you due to deductions they are often able to get there earned income to well below $15,000 a year and pay little if any income taxes…all legally I might add.

    This is great except that means it leaves very little contribution room for RRSPs as they are based on your net profit after all your business expenses have been deducted and they are not based on your revenue for the year. On top of that since your earned income is at the lowest tax bracket you receive a very small if any refund when you put the money in, but would have to pay income taxes when taking it out.

    So for people who are small-time self employed individuals having a tax free account that is not based at all on the size of your income and being able to put money in and take earned investment income out tax-free and then re-contribute that money later if desired is a huge plus….

    Anyways I intend on Maximizing my RRSPs and Maximizing this new TFSA…both will be of great benefit to Canadians in the future.

    Feb 28th, 2008 @ 11:46 am

37. 39. An American in Halifax

    Anybody have any idea how this TFSA would be treated by the US govt for dual citizens? I’ve got a lot of US stocks that are non-registered because of the hassle of potentially moving back to the States and having to collapse an RRSP. Would the TFSA be any help in sheltering?

    Feb 28th, 2008 @ 12:11 pm

38. 40. Russ Green

    Can existing investments be put into the TSFA? For example, if I buy a 5 year GIC today, can I transfer it into the TFSA next year when the plan comes into being?

    Mar 1st, 2008 @ 8:39 pm

39. 41. George

    Russ: probably, but that’s going to be one of the details that the TFSA providers (banks etc) will have to work out. I can’t see any reason why you shouldn’t be able to transfer an existing non-registered investment into a TFSA, though.

    Mar 1st, 2008 @ 9:15 pm

40. 42. Ed Rempel

    Hi American,

    I assume TSFA’s will not be recognized by other countries, just like RRSP’s. However, you have potentially a big advantage. Because of the tax treaty, withdrawing your RRSP in a lump sum after moving back to the US would result in only 15% withholding tax. Capital gains in your RRSP would be taxable in the US, but you can plan to avoid the tax on this by chrystallizing the gains before moving.

    I don’t know your situation, but perhaps RRSP’s are better than non-registered for you.

    Ed

    Mar 4th, 2008 @ 12:23 am

41. 43. Ed Rempel

    Hi All,

    We are just starting to analyze the TFSA, but it seems they beat RRSP’s most of the time. Credit Stephen Harper for implementing what may become one of the most effective tax tools for most Canadians.

    Commander T’s comment #22 shows RRSP’s with the contribution grossed-up being being ahead of TFSA’s, but only because of the assumption of a lower tax rate after retirement.

    However, most people do not gross up their RRSP contributions and most spend at least part of the refund. Also, the clawbacks on seniors affect most tax brackets, so the assumption of lower marginal tax rates after retirement is probably not true.

    Both RRSP’s and TFSA’s will beat most non-registered investment because of the tax on growth or income, but leverage (done right) and the Smith Manoeuvre should beat both.

    We suspect that they will be used much less than RRSP’s anyway, since the tax refund is a huge motivation for most people contributing.

    Our preliminary analysis is quite fascinating and will make several great topics for upcoming articles on MDJ.

    Ed

    Mar 4th, 2008 @ 1:35 am

42. 49. Frnk

    How can the TFSA be used as a vehicle to invest and actively trade in stocks?

    Is the interest gained on the savings account balance tax free, or is there a mechanism to open a stock trading account inside the TFSA?

    little confused as to how the TFSA can be used to procure tax free capital gains on active stock trading activity

    May 4th, 2008 @ 2:49 am

43. 50. FrugalTrader

    Frnk, the way that I understand the TFSA is that it can be held within a discount brokerage account, like an RRSP can be.

    May 4th, 2008 @ 5:21 am

44. 51. JR

    FT:

    In case that I missed it somewhere, even I dont know how the setting up the so-called TFSA works, for either a bank or a brokerage account … can some explain it clearly.

    All I want to know is will the bank or broker firm label it aTFSA, or will this be a special pre-fix to an account number (so revenue canada knows), or is there some other special mechnnism, and how for tax purposes is it differentiated from regular taxable accounts?

    Anyone that knows the mechanism 100%, please post it.

    Thanks

    May 4th, 2008 @ 8:28 am

45. 52. George

    JR: TFSA accounts don’t exist yet, and won’t exist until early 2009. The most likely scenario is that the accounts will be registered with CRA and tied to your Social Insurance Number (just like an RRSP) and the financial institution will have to report contributions and withdrawals on a yearly basis. You’ll get a tax slip indicating the amount contributed and/or withdrawn, and for tax purposes any gains (interest, dividends, within that account will simply occur without any taxable consequence - no taxes will be withheld and the gains won’t need to be reported on your tax return.

    Of course, this is my guess based on my knowledge of the current tax system. Nobody knows the exact details “100%” because those details haven’t been finalized and announced by the government.

    May 4th, 2008 @ 2:16 pm

46. 53. JR

    now that makes me nervous George… post 52 & 53

    FT, is your blog letting any posters use other posters ID’s?

    George, I always liked that name …. George

    Can you fix the problem FT?

    May 4th, 2008 @ 3:10 pm

47. 54. JR

    fixed FT, that was quick.

    Now are you sure that I or others cant post using someone elses ID?

    May 4th, 2008 @ 3:14 pm

48. 55. Ricky

    Does anyone have a guess as to whether you’ll be able to trade stocks on margin inside the TFSA?

    Jun 19th, 2008 @ 9:55 am

Trackbacks

1. Tax Free Savings Account in Canada - Feb 28th, 2008
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5. TFSA vs RRSP - Clawbacks & Income Tax on Seniors | Million Dollar Journey - Mar 12th, 2008
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7. TFSA vs. RRSP - Best Retirement Vehicle? | Million Dollar Journey - Apr 10th, 2008

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