“I don’t use my TFSA for short-term savings,” says Avrom Digance. “I’m a do-it-yourselfer, and for me the TFSA’s power is as a retirement savings vehicle.” Digance, a health-care worker in Vancouver, has $4,300 in his TFSA, mostly in TD e-Series index funds, which MoneySense has long recommended for building a Couch Potato portfolio.
While Digance admits that his TFSA holdings are small, that’s because it’s only been up and running since February. “My plan is to test drive the Couch Potato strategy for five years. As it grows, I plan to use it as collateral for borrowing money to invest in dividend-paying stocks outside my TFSA,” says Digance, who writes a blog at DividendNinja.com. “I’m 45, so I feel I have to make up for lost time with my investments. I’m willing to use a bit of leverage to do so, but no speculative stocks.”
Digance has thought out his strategy carefully. He has a good defined benefit pension plan, and when he retires he expects a healthy income from his pension and other investments. “I don’t like RRSPs because of the rules that will force me to withdraw some of that money at a specified future date,” says Digance. “When I look down the road, I see that RRSP withdrawals may result in clawbacks of my government benefits. I want to avoid that if I can.”
What the experts say
“I’m a proponent of passive investing using index funds or exchange-traded funds (ETFs)—or at least low-cost, low turnover portfolios like Digance’s,” says Heath, the financial planner. “But I’m leery of his aspirations about borrowing to invest. It’s a strategy that may work in theory, but in practice, that’s not always the case.” Sure, if you can borrow money at 3% and earn a 6% return, that’s great. But as we’ve seen over the last decade or so, equity returns can be flat or negative for several years.
Lamontagne agrees and adds, “If you must borrow to invest, a better way is to use your house as collateral and get a secured line of credit, which also tends to offer the lowest lending rates.”
Digance’s concerns about clawbacks due to RRSP withdrawals are valid, and that’s one reason people really should weigh the pros and cons of RRSPs versus TFSAs. The key is to remember that when you withdraw money from your RRSP in retirement, that money is treated as income, and you are taxed on it just as if you had earned it that year. When you withdraw money from your TFSA, however, it’s treated like any other account withdrawal, and you don’t have to pay tax.
“In cases where post-65 retirement income is expected to be over $65,000 a year, then it makes sense to maximize the TFSA first before making an RRSP contribution,” says Lamontagne. “This reduces the possibility of being hit with the Old Age Security (OAS) clawback.”