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

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
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