The near doubling of annual contribution limits for the tax-free savings account has prompted a rethink of how Canadians should invest for their retirement.
Many in the investment community are now seeing the TFSA as an attractive supplement, if not even alternative, to the traditional registered retired savings plan. It also makes the savings vehicle more attractive for holding riskier investments, such as equities, that can produce larger returns over the long haul.
The federal budget this week called for the annual TFSA contribution limit to rise to $10,000 from $5,500. A spokeswoman for Finance Minister Joe Oliver said Wednesday that Canadians can start contributing the extra amount "immediately."
For those investors who have never contributed to a TFSA, they have now accumulated $41,000 in contribution room – and that will continue to grow at $10,000 a year. Investment income earned in a TFSA, and withdrawals when they are made, are tax free.
For investment advisers, the announcement is opening a window of opportunity for more efficient financial planning for clients, particularly seniors.
Gregor McDonald, a financial planner with Vision Financial Planning, would like to see more of his clients taking advantage of the tax withdrawal benefits. Up until now, most people use the TFSA as a savings vehicle for near-term expenditures, such as a new car or home renovation. The increased limit could change that.
"With the increased limit I recommend using it for longer-term purposes like retirement, especially for those in their 50's and preparing for retirement," Mr. McDonald says. "That will mean using investment vehicles that are longer term in nature. I see people steering away from using balanced funds or fixed income products and increasing the equity content in their TFSA when portfolios start getting larger."
Over a 25-year span, and assuming a modest 4 per cent annual return, investors could still accumulate approximately $416,500. Not quite the chump change investors originally thought of when the TFSA was first announced with contribution room of $5,000 a year, says Adrian Mastracci, a portfolio manager at KCM Wealth Management Inc.
"Going from $5,500 to $10,000 really boosts this investment vehicle into the big leagues," Mr. Mastracci says.
As the TFSA becomes a larger part of people's planning and thus holds a larger share of their portfolio, clients should use a well-balanced approach to investing in their TFSA, says Darren Coleman, an investment adviser and portfolio manager with Raymond James Ltd.
"Rather than seeing the TFSA as a small account that was secondary to, say, their RRSP, which had the bulk of their savings, they should view the TFSA as a central and core part of the portfolio and manage it accordingly," says Mr. Coleman, who manages $115-million in assets under management.
As investors start to reconsider the TFSA, they should also reconsider the investments held within the account. A high percentage of investment dollars being contributed to TFSAs continue to sit in low interest rate products such as guaranteed investment certificates or high-interest savings accounts.
At the same time, investors should be careful about generating capital losses inside a TFSA, as it cannot be used to offset gains, as they can in a non-registered account.
Mr. Coleman suggests most clients should use the TFSA for holding investments that normally attract a high level of tax, such as fixed income and foreign dividends.
For retirees, the increased limit has placed a greater light on TFSAs being efficient tools to use in tax planning. When the TFSA was first introduced, Mr. Coleman started to work on investment projections for clients using a TFSA.
These projections looked at shifting RRSP withdrawal timelines. But it was a strategy Mr. Coleman couldn't implement fully until there was significant room available in the TFSA.
"With the higher TFSA limit, a lot of traditional planning with respect to RRSPs is being turned on its head," Mr. Coleman says. Historically, clients were advised to wait to draw from their RRSPs and RRIFs (registered retirement income funds) for as long as possible so they continue to have tax-sheltered compounded growth. But with an investment vehicle that can offer great tax planning, that isn't necessarily the case any more.
"We have another vehicle that is becoming much more useful with tax-free growth, and we are running the math and seeing that instead of waiting until someone is in their 70's, we should be drawing out smaller amounts of money earlier than we historically would've but at a lower rate of tax over all and then shift it into the TFSA," Mr. Coleman says.
The new $10,000 limit could also provide an alternative for clients looking to save for a down payment on the purchase of a home. Many younger clients currently benefit from the first time home buyers' plan, which allows a percentage of RRSP funds to be used towards a purchase of a home.
"For young people buying their first house or condo in their 20s or early 30s, the advice we have been giving if you are in a lower tax bracket is don't even contribute to an RRSP because chances are you will be in a higher bracket when you have to take it out," says Jamie Golombek, managing director, tax and estate planning at CIBC Wealth Advisory Services.
Clients also have the added benefit of having a flexible repayment plan, says Mr. Golombek, as anything taken out of the TFSA will be added to your contribution room for the following year (unlike the home buyers plan, which requires investors to start repaying the fund two years after the withdrawal).
Clare O’Hara