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How to get richer, faster: Dump the cash for equities in your TFSAs

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If a 30-year-old couple opened their first Tax Free Savings Accounts today, they could contribute up to $82,000, which is a big reason why such accounts are starting to be serious money for many Canadians.

As far as investing the funds, they could choose cash, GICs, stocks, bonds and preferred shares, as well as use vehicles such as mutual funds and exchange-traded funds to hold those investments.

According to a BMO study from October 2014, 48 per cent of Canadians have a TFSA. What is shocking is that 60 per cent of TFSA owners’ accounts are primarily made up of cash and 20 per cent are primarily made up of GICs.

Most of the cash and GICs are earning 0.5 to two per cent. Anything more is usually a very short-term teaser rate.

Why would you be happy earning such a paltry amount and why is so much sitting in cash?

There are a few reasons.

One is that many institutions initially didn’t really promote TFSAs because it was just a $5,000 or $10,000 account. The company that did a great job promoting it was ING Bank (now Tangerine), and it primarily offered high-interest cash accounts.

Another reason is that many Canadians still don’t know that they are able to invest in virtually anything in a TFSA — just like they can in an RRSP.

Finally, many Canadians were so nervous about stock markets when TFSAs started in 2009 that they didn’t want to have any risk in their TFSA savings, so that became their safe money investment — and it never changed.

If your TFSA is truly for short-term savings goals, and you will likely be spending the money in the next year or two, then it is entirely reasonable to invest in cash or GICs.

If, however, your TFSA is meant for retirement savings, it is simply bad money management from an investment perspective to have funds that are guaranteed to earn less than two per cent as a key piece of your long-term strategy.

For a wide number of reasons, stocks over the long term have significantly outperformed cash savings and GICs.

Based on information provided by Morningstar, here are the following rates of returns since 1950 for different investment indexes:

  • U.S. large-cap stocks in Canadian dollars: 11.2 per cent
  • Canadian large-cap stocks: 9.9 per cent
  • Canadian long-term bonds: 7.5 per cent
  • Five-year GIC rates: 6.7 per cent
  • 90-day T-bill rates: 5.5 per cent

These percentages clearly show that over the long run, stocks outperform bonds, bonds outperform five-year GICs, and five-year GICs outperform 90-day T-bills, but these rates of return do not truly show the impact.

To put it a different way, if you invested $5,000 in each of those asset classes, and they earned those rates for 30 years, this is the amount you would end up with:

  • U.S. large-cap stocks in Canadian dollars: $120,813
  • Canadian large-cap stocks: $84,899
  • Canadian long-term bonds: $43,775
  • Five-year GIC rates: $34,987
  • 90-day T-bill rates: $24,920

Displayed this way, it is very clear what you are potentially giving up by making long-term investments too conservative.

In addition, while we do not know what the next 30 years will bring, we do know for certain that the five-year GICs will pay you two to three per cent, and savings accounts currently pay 0.5 to two per cent. None of those numbers comes close to the long-term average returns of stocks or long-term bonds.

Some will say that now is not the time to start taking more risks with TFSA assets, but that’s egotistical thinking. You would be saying that even though the long-term history suggests cash is a weak investment, you know what is going to happen in the stock and bond market, and you know that it is better to be in cash for the next short-term period.

If you believe that, you may turn out to be correct for the next three months or even 12 months. But you may also be very wrong. And I am very certain that over the next decade or two, you will be making an investment mistake to have your TFSA sitting in cash or GICs.

Now that TFSAs are starting to be real money, it is time to rethink your low-risk TFSA investment strategy. With $82,000 of investment room for a couple, it is time to get serious about this important part of your retirement savings.
 
Reproduced from the National Post newspaper article 29th May 2015.

Ted Rechtshaffen
Written By:
Ted Rechtshaffen, MBA, CFP
President and CEO
tedr@tridelta.ca
(416) 733-3292 x 221

TFSA Increases and RRIF Minimum Changes – Two Advantages for many of you

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coupleAs most of you are now aware, last month’s budget brought two important personal finance changes.

The first is that TFSA annual contribution limits are now up to $10,000 annually, and the second is that if you have a RRIF, the minimum that you are able to withdraw has been lowered for all ages up to 94.

The TFSA changes will be important for many Canadians, especially younger ones who have years to build up TFSA room.

Asher Tward and Ted Rechtshaffen wrote a couple of articles on this topic in the National Post, showing how a middle class and upper middle class family could save over $1 million in their lifetime with the TFSA vs. the world without TFSAs:

A world with TFSAs vs without: Guess which can help a middle-class couple save $1.1M?
and
A world with TFSAs vs without, Part II: Which helps a family with a modest income save an extra $1.5M?

TFSA Action Item – You now have $4,500 in new contribution room for 2015. We will be discussing this contribution space with clients over the next few weeks.

On the RRIF, the chart below shows the change to RRIF Minimum Withdrawals. For example, at age 71, you had to withdraw 7.38% of your beginning year RRIF balance. Now it has been lowered to 5.28%.

RRIF Action Item – In many cases, this won’t have an effect on you. If, however, you are currently taking out the minimum RRIF balance, your Wealth Advisor will connect with you on whether you want to lower the withdrawal amount to the new lower minimum or not.

New Withdrawal Old Withdrawal
Age Minimums Minimums
71 5.28% 7.38%
72 5.40% 7.48%
73 5.53% 7.59%
74 5.67% 7.71%
75 5.82% 7.85%
76 5.98% 7.99%
77 6.17% 8.15%
78 6.36% 8.33%
79 6.58% 8.53%
80 6.82% 8.75%
81 7.08% 8.99%
82 7.38% 9.27%
83 7.71% 9.58%
84 8.08% 9.93%
85 8.51% 10.33%
86 8.99% 10.79%
87 9.55% 11.33%
88 10.21% 11.96%
89 10.99% 12.71%
90 11.92% 13.62%
91 13.06% 14.73%
92 14.49% 16.12%
93 16.34% 17.92%
94 18.79% 20.00%
95 20.00% 20.00%
Ted Rechtshaffen
Written By:
Ted Rechtshaffen, MBA, CFP
President and CEO
tedr@tridelta.ca
(416) 733-3292 x 221

A world with TFSAs vs without, Part II: Which helps a family with a modest income save an extra $1.5M?

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Recently we did an analysis of a world before TFSAs vs. the world today that took some flak online. Using a 40-year-old couple with $80,000 of income each, and $100,000 of annual expenses, we concluded that they could save $1.1 million of taxes in their lifetime as compared to the world without TFSAs.

There was a great deal of feedback, much of it centered on the fact that most Canadians do not have household incomes of $160,000.

What happens if you lower income to, say, $56,000 each and make the entire scenario more modest?

My colleague Asher Tward at TriDelta Financial and I redid the scenario as follows:

In this model, the family looks like this:

  • 40-year-old couple, Mary and Peter, with an eight-year-old daughter.
  • They are both working, earning $56,000 each with no pension.
  • They are spending $65,000 a year, growing with inflation.  There are small adjustments downward after the mortgage is paid, and after the husband passes away.
  • They are good savers, and are able to contribute $10,000 each per year to their RRSP in one option, and to their TFSA in the other option.
  • They live in a home valued at $650,000, and they have a $300,000 mortgage.  The home was bought 10 years earlier, and they put down $40,000 at the time, that was an inheritance from a grandparent.
  • In the RRSP world, they each have $173,000 saved, and also have $25,000 in non-registered savings.  In the TFSA world, they have $130,000 each saved in RRSPs, $43,000 each saved in TFSAs, and $25,000 of combined non-registered savings.
  • It is assumed that investments grow at six per cent, inflation is 2.2 per cent and real estate grows at 3.5 per cent.
  • They both retire at age 58.
  • Peter passes away at 79, and Mary passes away at 89.

How does it play out, in this Back to the Future scenario, Part II?

Under both scenarios Mary and Peter are able to live a comfortable retirement.  Their modest lifestyle that they maintained throughout their life continued in retirement.

While they could have spent much more, or gifted more during their lifetime, this analysis assumes that they didn’t.

In 50 years in the RRSP only model, they have an estate value of $8 million.  This would be roughly $2.67 million in current dollars.

In 50 years in the TFSA only model (after age 40), they have an estate value of $9.5 million – or $1.5 million higher in future dollars. If they live longer, the financial benefit will only grow.

The actual tax savings are quite significant. There is now $1.9 million of lifetime tax savings in the TFSA version vs. the RRSP version.

This results from several components, but the biggest is that, with an income of $56,000, the percentage tax savings on RRSP contributions were roughly 31 per cent in Ontario.  When the surviving spouse passes away, they still have $1.7 million of RRIF assets that will get taxed at about 48 per cent.  In the TFSA version, their RRIF assets are down to $0 in their early 70s.  From that point forward, their tax bill is extremely small.

In a middle class scenario, the TFSA continues to provide sizable benefits.  Even if this couple could only save $5,000 each for many years, they still could end up using the full $10,000 of TFSA room if they ever downsized their home, or received an inheritance from their parents.

The TFSA is not just a benefit for this year, but one for a lifetime of savings and tax benefits.  When viewed from a long term perspective, the TFSA will be of great benefit to a large majority Canadians.

Of course, one question remains – how will future government programs evolve to pay for this?
 
Reproduced from the National Post newspaper article 1st May 2015.

Ted Rechtshaffen
Written By:
Ted Rechtshaffen, MBA, CFP
President and CEO
tedr@tridelta.ca
(416) 733-3292 x 221

A world with TFSAs vs without: Guess which can help a middle-class couple save $1.1M?

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Will the tax-free savings account’s expansion only help the rich? That seems to be the popular belief, but the middle class may in fact be the biggest beneficiaries of all.

It might not be that noticeable for a few years, but crunch the numbers and there is strong evidence it will make retirement immensely better, especially for those under 50.

We decided to contrast a “with” and a “without” scenario, now that the Harper government has expanded TFSA contribution room significantly to $10,000 per person per year, for an average middle-class couple.

The definition of middle class is not that easy to identify. We chose a couple earning $80,000 each per year. (There were 111,000 people on the Ontario Sunshine list making $100,000 plus before pensions, so we picked a figure meaningfully lower than that.)

My colleague at TriDelta Financial, Asher Tward, and I based our calculations on a 40-year-old couple and found that they could see lifetime tax savings of over $1.1 million and an estate value of $670,000 more in the TFSA world versus a world where no TFSA existed.

Tward built a financial projection for our model couple based on these variables:

  • Plan to retire at age 58
  • Both earn $80,000 a year and have no pension
  • They have two children, 8 and 10
  • They own a house worth $750,000 with a $300,000 mortgage and no other debts
  • They spend $100,000 a year after tax – growing with inflation
  • They currently have $150,000 each in their RRSP, $43,000 each in their TFSA, and $25,000 in total in non-registered savings/bank accounts.
  • In our non-TFSA world, we assume they both had an RRSP of $193,000 and $0 in TFSAs.
  • In both cases we assume 6 per cent annual growth rate on investments, 2.2 per cent annual inflation, and 3.5 per cent annual growth in real estate.

The World Where the TFSA Never Existed

Joe and Mary are able to put $10,000 a year into each of their RRSPs. With their steady savings, they have set their goal to retire at age 58, and are confident they can do so.

At retirement they are sitting with almost $1.8 million in RRSP assets, and $590,000 of non-registered savings – which can’t move to TFSAs because they don’t exist in this alternative universe. Their house is now worth $1.4 million and is pretty much paid off.

They decide to fund their first year of retirement by drawing some money from their RRSPs and some from their non-registered savings. (We are showing $45,000 being withdrawn from each of their RRSPs.) This plan works well for them, keeps taxes moderate each year, and they are living a nice lifestyle.

Unfortunately, Joe passes away at 79. Now everything changes. The newly widowed Mary is going to be fine financially, but her tax bill has just shot up.

Joe’s RRIF now passes to Mary, and she has a $2 million RRIF (in future dollars), no ability to split income, and even with lower forced RRIF withdrawals, will likely not only lose her husband’s Canada Pension Plan and Old Age Security, but also her own OAS.

When Mary passes away at 89, there is still over $1 million in the RRIF, and this will get taxed at an average rate of around 47 per cent.

The upshot

Joe and Mary paid total cumulative income tax of $2,359,000: the amount they paid each year, plus the payout on Mary’s terminal tax return.

They were able to pass along an estate, after tax, of $4,519,000, in future dollars. In today’s dollars at a 2.2 per cent inflation rate, that would be about $1.5 million – much of which came from their house where they stayed until the end.

The Real World with the TFSA

In this world, they start in the same place, but the TFSA has been in place since 2009.

To keep things simple, we assume that Joe and Mary decided to stop RRSP contributions altogether in 2015, and maximize their TFSA contributions every year instead, at $10,000 each.

In year one of retirement, they decide that they will start drawing a decent amount from their RRSPs because they won’t be receiving any CPP or OAS. They will take CPP at age 65 and OAS at age 67.

Their RRSPs that were $150,000 at age 40 have still grown to $450,000 from investment growth. They both draw $50,000 from their RRSPs, and the rest from some non-registered savings that had accumulated. Even with the $100,000 of RRSP withdrawals, their combined taxes paid are only around $14,000. (This assumes that today’s tax brackets have grown at the rate of inflation.)

By age 74 they have already drawn their RRIFs down to $0, but between the two of them, they now have almost $1.7 million in their TFSAs. They have full CPP and OAS (funding $80,000 in future dollars between both of them), and the rest is drawn down from TFSAs and the small amount of non-registered savings. Their total tax bill is only about $6,000, virtually all from their government benefits.

For the next five years, Joe and Mary live very comfortably, and pay very little tax despite having a net worth north of $4.2 million.

Unfortunately, at 79, Joe passes away. Fortunately for Mary, her financial picture doesn’t suddenly get meaningfully worse, as it does in the RRSP scenario. Now, Joe’s TFSA rolls into Mary’s TFSA, without any tax consequences whatsoever. Whether Mary draws $200,000 or $10,000 out of her TFSA, she still won’t pay tax.

When Mary passes away 10 years later at 89, she owns a house worth $4 million that has no capital gains because it is her principal residence. She has a TFSA worth over $1.1 million that has no tax issues. Other than probate fees on the estate, there are almost no taxes on her final tax bill.

Four key reasons for $1.1 million of tax savings:

  1. This couple will have significantly lower capital gains tax, as well as tax on interest and dividends in their lifetime. They will occasionally have non-registered/taxable assets, but for the most part the TFSA can minimize or eliminate these taxes.
  2. In the final 10 years when Mary is a widow, the tax savings become very large because she avoids the issue of doubling the size of her RRIF coupled with a forced withdrawal of over eight per cent each year.
  3. Being able to ultimately eliminate RRIF assets during their lifetime, Joe and Mary aren’t hit with a huge tax bill on their estate, which would have occurred if Mary was sitting on one million dollars in her RRIF at death. Canada Revenue Agency views these assets as income in her terminal tax filing.
  4. By being able to strategically withdraw from RRSPs in their lowest income years, and then drawing from TFSAs during years of meaningful CPP and OAS income, they can take advantage of the lower tax rates each year.

 
Reproduced from the National Post newspaper article 24th April 2015.

Ted Rechtshaffen
Written By:
Ted Rechtshaffen, MBA, CFP
President and CEO
tedr@tridelta.ca
(416) 733-3292 x 221
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