It’s a testament to the appeal of TFSAs that we can expect their total value to soon exceed the amount in RRSPs.
Tax-free savings accounts were launched in 2009, registered retirement savings plans 52 years earlier. TFSAs have come on strong because they’re an all-purpose savings vehicle that just clicks with people, but could they be more popular still?
A recent study by the Retirement and Savings Institute at business school HEC Montréal took a look at whether people are making the right choice between TFSAs and RRSPs. The conclusion is that while some demographics are making smart use of TFSAs, more education is needed.
But let’s not lose sight of the big picture, which is that TFSAs are a massive success when it comes to helping people save in a tax-friendly way. “We find that TFSAs have enjoyed tremendous growth since their inception,” the Retirement and Savings Institute study says. “The pace of growth is such that annual median contributions into TFSAs already outstrip RRSPs, and the total value of savings in them may end up surpassing those in RRSPs in the foreseeable future.”
The study found that almost half of all households have a TFSA and that 36 per cent have both TFSAs and RRSPs.
A quick primer on the differences between the two. With a TFSA, you contribute after-tax dollars and then benefit from tax-free appreciation and withdrawals. RRSPs give you a tax deduction for contributions, with the assets in an account growing with the benefit of tax sheltering until you make withdrawals, which are taxed as regular income.
Saving money in an RRSP or TFSA is a net positive, but there are consequences if you don’t get the choice right.
“Contributions into the ‘wrong’ savings vehicle can lower one’s effective returns on savings – potentially increasing taxes owing and/or lowering eligible government benefits – which in turn require more savings to meet retirement spending goals,” the Retirement and Savings Institute study says. Data in the study come from the 2019 Statistics Canada Survey of Financial Security.
TFSAs were billed in their debut in the 2008 federal budget as a “flexible savings vehicle” suitable for near- and long-term goals, with particular relevance to retirees and low-income people.
For retirees, TFSAs were said to offer a tax-efficient way to draw income and a home for funds they must withdraw from a registered retirement income fund but don’t immediately need for living costs. For low-income Canadians, TFSAs were described as a way to accumulate money they can withdraw in retirement without affecting eligibility for the Guaranteed Income Supplement.
The study says older households, notably those drawing down their retirement savings, are more likely than other age groups to have a TFSA and have the least room available relative to their contribution limit.
Low-income Canadians are switching from RRSPs to TFSAs, but the study says this may not be happening as fast as expected in light of the risk of GIS clawbacks resulting from RRSP or RRIF withdrawals.
Young people are another group leaning into TFSAs but could still be overusing RRSPs. “If they’re planning on using RRSPs as a long-term savings vehicle, that’s anecdotal evidence of money misplaced,” said Colin Busby, a co-author of the study along with Tessa LoRiggio.
TFSAs are ideal for young adults because they suit both short- and long-term goals. Money is easily withdrawn from a TFSA and can be replaced at a later date. Tax-wise, TFSAs also have something to offer young people.
Contributions to an RRSP when you’re young may generate a modest tax deduction in comparison with the tax owing on an RRSP or RRIF withdrawal long in the future, when the plan holder is in a higher tax bracket. With a TFSA, you’re done with taxes once you’ve made a contribution. TFSAs can be a win if you withdraw money when you’re in a high tax bracket.
Mr. Busby’s overall take on TFSAs is that they’re a very positive addition to the financial ecosystem. “It’s hard to say if people are necessarily saving more per se or if they’re saving for longer-term objectives,” he said. “But they are saving in tax-free ways, and saving is good because it also means investing.”
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Rob Carrick