TFSAs misunderstood by some investors

Popular investment strategy has built-in options


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If personal finance was a high school popularity contest, TFSAs would be at the top of the heap.

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Hey there, time traveller!
This article was published 31/08/2019 (1121 days ago), so information in it may no longer be current.

If personal finance was a high school popularity contest, TFSAs would be at the top of the heap.

Indeed, the account that allows for tax-sheltered growth and tax-free withdrawals is pretty cool.

At least money geeks (like me) seem to think so.

Graeme Roy / The Canadian Press files Some financial planners suggest investing in two TFSAs — one for near-term cash savings and one for long-term investments.

What’s more, the annual RBC financial independence in retirement poll — which has been taking the pulse of Canadian finances ever since the tax-free savings account was born in 2009 — has found TFSAs are now more widely held than RRSPs.

The survey found among those polled (more than 2,000 adult Canadians) that 57 per cent stated they had a TFSA compared with 52 per cent indicating they had an RRSP.

“That speaks to how those individuals are looking more for a savings vehicle that they can withdraw from with a bit more liquidity,” says Stuart Gray, director of RBC’s financial planning centre of expertise.

In non-financial geek speak: TFSAs are flexible, much more than an RRSP. You can use them for any goal — retirement, post-secondary education, buying a vehicle, emergencies and saving for a down payment on a home.

And RRSPs, well, they’re just for retirement.

That’s not to say they can’t be used for other needs, but the trouble is withdrawals are taxable.

The other cool thing about TFSAs is contribution room keeps growing by the year and is indexed to inflation. We can now contribute $6,000 annually (in 2009, it was just $5,000 annually).

And someone who turned 18 in 2009 now has a lifetime maximum of $63,500.

For a couple, that’s a handsome hunk of cash growing tax-free. Perhaps that explains why the TFSA is very popular among boomers. Their use of TFSAs is higher than the national average — 65 per cent. And they are more likely to have one than an RRSP, despite the fact many are still in the workforce with retirement lurking close by.

Gray says silver-haired folks love the TFSA for its tax-free and easy nature.

“When you’re looking at things like Old Age Security (OAS) and other benefits that may be income-tested, withdrawals from the TFSA will not be included in that calculation.”

It just makes building a low-tax retirement income that much more simple.

And yet, one has to wonder how well this widely held tax-sheltering account is actually understood. The reason being a large number of Canadians appear to be using TFSAs as simple savings accounts. The survey found 42 per cent are holding cash in savings.

That’s a large number of individuals sheltering two per cent or less of interest a year. By contrast, they could invest for the long-term in stocks, bonds and other investments that on average provide much higher returns on money. In turn, they save more in taxes.

For Mark Keating, who heads up the marketing arm of Nest Wealth (a robo-advisory firm), it’s not surprising TFSAs are both popular and often misused.

“There’s definitely a misconception about what it is and how to use it properly.”

He believes the reason for this is a lack of access to advice. Many Canadians don’t get good financial advice.

Another problem is its name.

“That’s a big pet peeve of mine, how it was named,” he says.

In fact, most experts agree on this point. Then again, RRSPs are registered retirement savings plans. And a BMO study found 60 per cent of Canadians also put their contributions into savings as opposed to investments. So perhaps both accounts could have the “savings” in their monikers replaced with “investment.”

But Keating further notes TFSAs have generally not been marketed well.

“A question we get a lot from people is ‘What is your TFSA rate?’”

He argues that many financial institutions created marketing campaigns that offer high-interest savings accounts for TFSAs. And that has led people to believe TFSAs are only just savings accounts.

Then again, the survey points to many Canadians having a good reason for their TFSAs containing highly liquid (easily cashable) savings. It found many used TFSAs as an emergency savings accounts (35 per cent), trailing only retirement (38 per cent).

Using TFSAs for emergencies is fairly prudent, says one of the co-founders of a fintech company offering free online financial planning services.

“An emergency fund is cash you have access to whenever you need it,” says Eric Rogness, vice-president of client experience with Planswell.

And TFSAs offer that in spades.

Yet the Toronto-based firm’s computer modelling — used to help build its free plans — suggests individuals should still “invest” in a portfolio of stocks and bonds as opposed to holding it in near-cash savings.

“If on the day you need funds, and the market is down, taking the money out and locking in the loss is OK,” he says.

That’s because you get TFSA contribution room back at the start of a new year, and can reinvest. And so “over the course of your career, the investment gains will make up for those short-term losses.”

In contrast, the cost of keeping $40,000 over the long-term in a TFSA as a low-interest savings account for emergencies over the long term could be about $100,000 in lost investment opportunity, Rogness says.

If locking in a loss turns your stomach, you can also create multiple TFSA accounts, Keating says.

You can have one for emergencies in a high-interest savings account or short-term GICs and the rest could go into another TFSA, invested for the long term.

Keating points out that many investors may be unaware these choices for investing in TFSAs actually exist.

So, while popular, TFSAs are still a little bit misunderstood.

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