Happy 10th Birthday, TFSA!

 It seems like yesterday.  But it’s not! 

It has been ten years since the “new kid on the block” was introduced to Canadians.  This coming January we sing, “Happy Birthday!” to the Tax Free Savings Account (TFSA). 

When the TFSA was first introduced in 2009, I was working as an Investment Specialist.  I remember those initial conversations with clients. The contribution limit of $5,000 for some seemed so insignificant; they could not see the benefits of investing their money in a TFSA to shelter the modest investment income they would earned in that first year. However, for a couple, sheltering the income on $10,000 proved to be a great starting point.

Now look at the total contribution limit! 

Canada Revenue Agency (CRA) recently announced the contribution for 2019 would be raised to $6,000, a modest increase from the previous three years’ limit of $5,500.  If an investor has been faithfully socking away money into this favorable investment account, as of January 1^st the total limit will be $63,500.  What first may have appeared as an insignificant amount ten years ago has certainly become attractive for any individual or couple looking to protect investment income from being taxed. 

The majority of seniors who held money in non-registered investments embraced the new investment account.  Every year they would transition money subjected to taxation into the haven of the TFSA where taxation was prohibited. Rightly so!  They lowered their total income.  In turn, they could take advantage of the potential tax credits and government benefits.  

  

What You Need To Know

1.  Which is better?

The confusion begins with people who are currently employed and cannot decide whether TFSAs or RRSPs are a better fit for their needs.  Like any investment products, both have their pros and cons.

When money is invested into Registered Retirement Savings Accounts (RRSP), the contribution reduces the annual taxable income (advantage).  When the money is withdrawn from this safe-haven, the withdrawal amount, like employment income, adds to the annual taxable income (disadvantage).  The opposite is true with a TFSA.  A contribution to a TFSA does not reduce taxable income and likewise a withdrawal from a TFSA does not increase taxable income.

2.  Where’s the answer?   

Deciding which investment account is better suited to your needs, the answer is determined by asking, “What are your goals?”  The diagram below is quite clear about identifying three things: your goals, time horizon, and risk tolerance.  Playing the guessing game to determine which investment product will work is pointless.  Once you clearly recognize what you want to achieve, then you can evaluate your time horizon and risk tolerance.  

3.  What’s in a name?

Many articles place blame on the name, Tax Free Savings Account.  Most people associate the word, “savings”, with an investment made in a low-interest earning account.  What you need to know is the sky’s the limit when you are deciding where to invest your money. Your choices are everything from a daily savings account to GICs, stocks, bonds, mutual funds, and exchange-traded funds.

4.  Where’s the secret?     

If you are one of many people who are caught at the impasse of saving for retirement and cannot decide which investment account is more advantageous, the secret is in your taxable income.  Your marginal tax rate (MTR) is your deciding factor.  The MTR is the rate of tax you will pay on your next dollar of income, both federal and provincial.  As your income climbs higher from one tax bracket to the next so will your marginal tax rate. 

For example, if your annual income is $50,000, then your marginal tax rate (MTR) is 33% (20.5% Federal + 12.5% Saskatchewan).     

5. What’s the difference? 

Once you know your MTR, then you are ready for the next question. 

“Will your retirement income be higher or lower than it is currently when you make the contribution?” 

Once you know this, you have your choice.

6.  What’s another tactic?

To simplify the process, the chart below asks you to pick an answer (higher or lower) to determine an appropriate strategy. 

If your MTR for RRSP contribution is (higher or lower) and the MTR for RRSP withdrawal is (higher or lower), the following is more advantageous.   

7.   When’s the right time?

I understand timing is everything.  Many Canadians are self-employed and their savings are invested back into their businesses for good reasons.  These Canadians have not capitalized on the Tax Free Savings Accounts yet because the opportunity has not been presented.   Whenever the sale of their businesses or real estate does occur, they will seize the chance to tuck money into the TFSA.  The benefit of the TFSA is the ability to carry forward the contribution room into the future.  If you are one who has not opened a TFSA account, you should know that you can when the time is right for you.  The interesting fact is you can give money to your spouse and children to invest in their TFSA without any questions. 

8.  What’s the hidden trick?

A point of interest that deserves your attention is your TFSA contribution room may actually increase without your knowledge.  When you earn money on your investments (interest, dividends, or capital gains) and then opt to withdraw funds from your TFSA, the following year you can replace the full amount of your withdrawal plus the current year’s new TFSA limit.  In all likelihood, your deposit may exceed the total contribution room offered to a first-time TFSA investor.

Here’s why.  The new annual calculation includes: your TFSA dollar limit, any unused TFSA contribution room from previous years, and any withdrawals made from the TFSA in the previous year.  It’s your earnings that essentially increased your contribution room.

In a nutshell, your annual contribution room can become uncertain if you are making regular deposits and withdrawals.  As a cautionary measure, always keep a record of your transactions to take advantage of topping up your TFSA and to avoid any penalties for over-contributions.

9.  What’s the benefit?      

The Tax-Free Savings Account has served Canadians well over the past ten years. I believe they have their place in everyone’s financial plan.   This investment account can serve multiple purposes depending on individual or household needs.  Whether you are saving for something specific, like a vehicle, or funding discretionary items, like the occasional winter getaway, money can be tucked away inside a TFSA so it’s out of sight and out of mind. 

Happy 10^th Birthday, TFSA!

You’re making dreams and wishes come true!

But I believe we have to do our part.  

The encouragement is “Never under-estimate your effort, no matter how little.  Every effort, little or great is a step closer towards the actualization of your dreams.” (Chinonye. J. Chidolue)

If the effort simply means we open a TFSA account, commit to regular deposits and save money on taxes, then we are closer to our dreams.  Are we willing to give this task a little effort? Your answer needs to be a resounding, “Yes!”  

Doing What’s Right Has to Be Right for You

Good or Bad

No surprise here. February is often associated with Valentines’ Day.  Financial advisors and planners generally look beyond this day to the March 1^st deadline which requires clients to make their RRSP contributions.

But what if you don’t have the money for the contribution? Do people consider borrowing money for their RRSP investments?  Curiosity caught up with me. I quickly searched the Internet.    Most articles leaned towards the negative.  Headlines blurted out harsh warnings, “It’s not the smart-money thing to do” and “Why you shouldn’t borrow for your RRSPs.”  

I did. I borrowed money for my RRSP investment.  As a single mom, there wasn’t extra cash to make a lump sum investment.  When you are in your mid-thirties, reality stares at you reminding you the clock is ticking down to your retirement years.  If you don’t start saving, you might not have enough.  I can attest the tax refund certainly helped pay off my loan quicker. 

I agree for the most part on the points made in the articles. But I trust you know yourself best and can demonstrate whether a strategy is the right thing for you.  My rebuttal is, “If the shoe fits, wear it”. When applied to whether to sign up for an RRSP loan, “If the strategy works, use it.”

   

Sometimes doing what’s right has to be right for you.  When you can’t get into the routine of saving regularly, borrowing the money for an RRSP might be one way to get you started.  First, let’s understand one thing. I am all in favor of an “anti-loan strategy”.  I probably sound hypocritical except for this additional piece of advice: this strategy is only encouraged to eventually wean you from making  RRSP loan payments into making regular RRSP contributions.

The Battle between “If” and “But”   

Here’s the war-on-words.

If you do this, you achieve success. But when you do that, you will be defeated.

If you borrow the money to invest into an RRSP, you begin saving for your retirement. 

But when you neglect your loan obligations and are unable to make your loan payments, then you have defeated your purpose and destroyed your credit in the process.

If you invest the borrowed money into an RRSP, you save on income taxes and the investment income compounds and the savings grow.

But when you withdraw money from your RRSP savings prior to your actual retirement date, you have lost sight of your retirement goal. 

To win the battle, you have to understand the commitment and consequences before you apply for the RRSP loan.  

An Impressive Balance Sheet

Borrowing money is the very thing many people are currently doing.  They are willing and able to set money aside for loan payments to buy vehicles and pay for their vacations {among other tangible and intangible things}.  Often loan payments are seen as a form of “forced savings”.  Borrowing money rather than saving is often considered the only way to acquire an asset. If we are willing to borrow, then let’s make a play for an important need. Why not implement this forced savings strategy as a temporary measure to build your RRSP savings?

The ultimate goal is to forge ahead and pay off your loan. When you do, your Balance Sheet will look impressive.  Eventually your Net Worth increases because you will still hold your investment asset once your loan is paid.   

Balance Sheet
Assets	Liabilities
RRSP Investment  $1,000	RRSP Loan          $1,000
	Net Worth            $       0

Balance Sheet
Assets	Liabilities
RRSP Investment  $1,000	RRSP Loan          $1,000
	Net Worth            $1,000

Behind the Scenes

In essence, we are trying to instill a new habit. When you create room for a loan payment in your budget, the intent is to eventually ditch the loan payment for a regular RRSP contribution.  When you also pay attention to the amount of interest paid on the borrowed money, you will ultimately be driven to avoid using a loan strategy as a means to build your retirement savings.  The overall plan is to kick start your retirement savings.  According to the 2016 Statistics, two-thirds of households are setting aside money for retirement.  The question is whether it is enough.

Your “Why”

Being aware of your circumstances, limitations and weaknesses, helps you make sound financial decisions that are right for you.  One piece of financial advice, from either this blog or anyone else’s, does not necessarily trump the other.  The financial strategies and advice are designed differently because peoples’ needs are different.  

Borrowing money for an RRSP investment might not be the ideal long-term plan.  The goal is to transition regular loan payments to monthly RRSP contributions.  The underlying motive is to plant a habit of investing a consistent amount of money to replace the income you currently earn. A small sacrifice today means a secure income for the future. 

How can we make this easy for you?  Children often ask the “Why” question. “Why do I have to do this?”  “Because” might be the answer which works for them; however, it might not work for you.  Understanding your “why” will cement your conviction to save when you are tempted to do other things with your money. Definitive SMART goals, whatever they may be, allow you to maintain your focus.

·       I want to work full-time until I am 55 years and then retire.

·       I want to be able to live my retirement dream with an annual income of $60,000.

Problematic Hurdles

Even before considering a loan strategy, you have to determine whether you would qualify for a loan. Borrowing money can often be equated to jumping hurdles.  I believe the important question which begs an answer is, “How much of a monthly payment can your income handle?  

Pushing through temptation to strive towards your goal might require a trade off.  You may need to make room for the payment by nitpicking through the details of your spending habits. What can you possibly give up that will help you meet your goal?

The Promise

When you embark on the strategy of borrowing money for an RRSP investment, you must pinky swear to make your loan payments on time and never-ever withdraw any money from your RRSP investment until you retire.

This strategy, like any other, is a way to achieve your retirement goal.  Your attitude and commitment determines the most appropriate fit for your financial plan.    When you rationalize borrowing money as a short-lived strategy to secure your retirement, you will meet success.

The real goal is to do something.  When you begin to shift your thinking to “this-must-be-done”, you will discover there are no shortcuts and quick fixes. Remember, you are doing this for your family and you. Once you make the connection, there’ll be a willingness to follow through consistently.  “It’s just the way it has to be because it is right for me.”