The RRSP advantage

With the government hinting it will double contribution room, everyone’s talking TFSAs. But the good old RRSP is still a better choice for most of us

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From the February/March 2015 issue of the magazine.

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These days you’d be hard-pressed to find a Canadian who isn’t clamouring for Prime Minister Stephen Harper to just get on with it and finally give us more TFSA room. The PM has hinted—strongly—that the annual contribution limit on Tax-Free Savings Accounts will soon be almost doubled, from $5,500 to at least $10,000, which could make the TFSA a serious player as a retirement savings tool. But John Storjohann, for one, just yawns at the news. Sure, the 58-year-old Calgary project manager likes TFSAs just fine, but for him, RRSPs will always come first when he puts money aside for retirement.

“I know my income when I’m retired is going to be a lot less than what I’m making now, and I don’t have a workplace pension plan,” he says. “I’m trying to max out my RRSP, but I’ve still got lots of contribution room left. After that, I’d start thinking more about the TFSA.”

Storjohann is keenly aware of the two main advantages of RRSPs: the tax refund when you make a contribution, and the tax-deferred growth until you make withdrawals in retirement. These make RRSPs ideal for those who expect to be in a lower tax bracket when they stop working—which will be the case for most Canadians. For those in the highest tax bracket today, the RRSP is a no-brainer. That’s why Storjohann’s always surprised when he meets people pulling in good incomes who think TFSAs stack up better than RRSPs. “People just don’t understand how these accounts work.”

While TFSAs let you earn a lifetime of tax-free growth, it’s fair to say that many Canadians are contributing to TFSAs when they shouldn’t be—a decision that may result in them paying higher taxes and having less income in retirement. Indeed, there are only a few instances when it makes sense to prioritize a TFSA over an RRSP. Read on and we’ll show you why RRSPs are still the best way for most people to build their wealth.

Lower taxes, bigger savings

(Photograph by Raina + Wilson)

(Photograph by Raina + Wilson)

Like many Canadians, Jessica Foster and her husband Jason are unsure whether they should invest in RRSPs or TFSAs. “We have lots of room left in both, but we aren’t sure what we should be contributing to first,” says Jessica, a 29-year-old lawyer in Toronto’s legal publishing industry. “We make decent money, but I don’t think we’re saving enough, and I am constantly worried about our ability to retire.”

Between paying off their mortgage and other living expenses, the Fosters can’t afford to max out both their RRSP and TFSA. But they’re concerned that building up substantial RRSPs might be “a tax time bomb” waiting to detonate in retirement, and think they could minimize future taxes by using a TFSA instead.

This is the most common objection to RRSPs: people simply hate the idea of paying taxes on the withdrawals. Money taken out of a TFSA, by contrast, is tax-free, which sounds far more appealing. But that logic ignores the fact that you receive a tax refund when you put money in an RRSP, while TFSA contributions are made with after-tax dollars. So for the Fosters and other Canadians weighing this decision, it comes down to whether it’s better to pay tax now or later. And that’s not an easy question to answer.

Pension expert Malcolm Hamilton, a senior fellow at the C.D. Howe Institute, sympathizes with the confusion over the matter. “It’s an annoyingly complicated question, and in a well-designed system it would be easy to answer it.”

Eric Kirzner, a professor at the University of Toronto’s Rotman School of Management, agrees. “Some financial planners get too deep in the weeds on this question, and the math associated with distinguishing the tax benefits are way too speculative,” he says.

Both Hamilton and Kirzner say that anyone earning more than $50,000 is usually better off prioritizing RRSPs over TFSAs. While both accounts allow your investments to grow tax-free, the tax refund makes the RRSP more attractive for high-income earners. You can contribute up to 18% of your previous year’s income—to a maximum of $24,930 for the 2015 tax year—and deduct that amount from your current income. You’ll eventually have to pay taxes on RRSP withdrawals in retirement, but if you earn less income in your post-working years, you will be taxed at a lower rate.

That, in a nutshell, is what makes RRSPs better than TFSAs for higher earners: Not only are you taxed on your money years later, but because you’re in a lower bracket when you retire, you’ll pay less tax too.

Reinvesting your tax refund also helps to supercharge your savings, thanks to the magic of compounding. That’s precisely what appeals to Jamie Kotlewski, a 26-year-old hospital pharmacist in Calgary. “Right now, I prefer my RRSP over my TFSA. It provides an instant tax refund that allows me to gross up my RRSP,” he says.

Say you’re contributing $5,000 to your RRSP each year and your marginal tax rate is 30%. If you reinvest your refund every time you get one, after 10 years your RRSP will be worth $90,000. If you don’t reinvest your refund, your RRSP will be worth just over $66,000—almost one-third less.

Better behaviour

When your income is between $35,000 and $50,000, the long-term tax differences between RRSPs and TFSAs become negligible, says Malcolm Hamilton. In that salary range, “just being able to put money aside in either an RRSP or a TFSA is great.”

But RRSPs can still be a better choice for reasons that don’t involve tax deferral or refunds. In his new book, Wealthing Like Rabbits, author Robert Brown makes the case for favouring RRSPs over TFSAs most of the time because the former usually means less temptation to access your retirement savings early.

Because money in a TFSA has already been taxed and any earnings on contributions are completely tax-free, Brown says it can be tempting to dig into your retirement fund for indulgences like a new car or a vacation. Even Jessica Foster admits one reason she’s averse to RRSPs is that she wouldn’t be able to access the money easily, perhaps for a home renovation. Brown says that’s precisely why she should use RRSPs: “If you take money out of your RRSP early, the tax man is going to nail you. Hard. Painfully. He will take up to 30% of your money at source, before you even see it,” he says. “It will cost you $4,500 in taxes on a $15,000 withdrawal.”

Jason Heath, a fee-only financial planner at Objective Financial Partners in Toronto, sees TFSAs being used unwisely all the time—particularly among the middle-class. “People have this idea that they should be using TFSAs because of the hype, and because planners tell them they should. But a lot of times TFSAs are promoted as a short-term savings tool, or an emergency fund. I’m not a fan of those kind of approaches.” Heath would rather see middle-income earners who are saving for retirement max out their RRSP first, and then use any additional disposable income to pay off their home more quickly. That’s precisely what Jamie Kotlewski does. “When I have finished maxing out my RRSPs I will pay down my mortgage and reinvest before I use a TFSA.”

Borrowing from yourself

As Robert Brown points out, withdrawals from an RRSP are usually taxable immediately. But there are a couple of federal government programs that allow you to tap your RRSP in special circumstances without paying tax on the withdrawals.

The Home Buyers’ Plan (HBP), introduced in 1992, allows first-time home buyers to withdraw up to $25,000 from their RRSP to put towards a down payment. In the case of a married or common-law couple, the combined tax-free withdrawal amount increases to $50,000, as both can pull $25,000 from their accounts.

Taking a big dent out of your home loan does more than just reduce the amount of interest you’ll pay. Banks don’t require mortgage insurance for buyers making a 20% down payment. So if borrowing from your RRSP allows you to get over that threshold, you’ll save thousands in mortgage insurance premiums.

The only catch with the HBP is that you will have to pay the money back, but you have up to 15 years to do so, starting the second year after the money was withdrawn. You need to report the repayments on your tax return each year—and you don’t get a tax break, because you got a refund when you made the original contribution.

If you’re returning to school as an adult, you can also take advantage of the Lifelong Learning Plan, which works in a similar way. The LLP allows you to withdraw up to $20,000 (no more than $10,000 in any year) from your RRSP if either you or your spouse is attending school. You have 10 years to pay it back, and the first repayment isn’t due until the fourth year after the first withdrawal.

Pension income splitting

No one relishes the idea of getting older, but one of the advantages of using an RRSP is that when you draw it down after age 65 you’re entitled to split up to 50% of the income with your partner. (Note that to qualify for income splitting the RRSP needs to be converted to a Registered Retirement Income Fund, or RRIF.) For senior couples in different tax brackets, this strategy can dramatically reduce their overall tax bill. Not only does it allow some of the RRIF income to be taxed in the hands of the lower-earning spouse, it can also reduce clawbacks on your Old Age Security (OAS) benefits. “That’s a valuable thing for some people,” says Malcolm Hamilton. “This makes the RRSP look more attractive compared to the TFSA, where income splitting is a non-issue.”

To use a simplified example, consider a fictional couple, Scott and Stefania, who are both 67. Stefania has little income or retirement savings, while Scott receives $60,000 a year from his RRIF and $30,000 from consulting work, in addition to his OAS and Canada Pension Plan benefits. Because Scott’s income is high, his marginal tax rate is 43% and his OAS is clawed back. But by splitting his RRIF income with Stefania, Scott can reduce his taxable income by $30,000, which lowers his tax bill and allows him to keep all of his OAS. Meanwhile, that $30,000 will be taxed in Stefania’s hands at a much lower rate, saving the family thousands of dollars.

As you can see, understanding the differences between the RRSP and TFSA retirement investing can save you a bundle in your post-working years. Both of these tax-sheltered accounts are useful tools that can help you hold onto more of your income—but only once you’ve determined which one works best for you.


24 comments on “The RRSP advantage

  1. It’s a good debate as to which is better… TFSA or RRSP. A person who is real good with their money would make solid contributions to thei RRSP, and throw the return on taxes to a TFSA. People who spend their tax returns are missing out on the true benefits of RRSP’s.


    • It’s true, most people just consider their tax refund a bonus and blow it on something. Then they complain when they have to pay taxes upon withdrawal from their RRSP.

      The article doesn’t address very low income seniors who may qualify for GIS. In that case RRSP’s count as income and reduce their GIS amount. In their case a TFSA is better.


      • Hi Judy,
        The assumption is that if a person earns more then $50,000 an RRSP is the better way to save. If, however, a person earns less (such as a low-income senior) then a TFSA may be a better saving strategy.


  2. I see a lot of text about why the RRSP is supposed to be better than TFSA but I dont see any detailed calculations.

    I have done the maths with about 10 people and EVERY TIME the TFSA is better than the RRSP. Even more so when you think about the the fact that your HAVE to withdraw money out of your RRSP as soon as you hit 70 and, if I remember correctly, the minimum % is quite high so if you have a lot of money, you may even have to pay more taxes than your last year working.

    Do the math for yourself and have the discipline to save.


    • What does the % you have to withdraw have to do with anything; it’s the % tax that you have to pay on that $$$ you have to withdraw that matters.

      Save for the weak last sentence, it sounds like you’re convinced that the TFSA is the way to go. That is fine, but please do not rag on “Why wasn’t this discussed” when if/when it turns out to be the other way.

      The numbers are in the article – if you make over $50,000/year, you should probably think RRSP first, and the reason is in the article: “You’ll eventually have to pay taxes on RRSP withdrawals in retirement, but if you earn less income in your post-working years, you will be taxed at a lower rate.”


      • I think the point is quite valid. I did the math and found the TFSA over the very long run to be the superior savings vessel. For one, many earners making over 50K likely have some form of pension at work. Also not figured into the calculation is that an RRSP effectively forces the contributor to a 5 years de-investment period when they are 65-70. This presents a risk if you are not tax optimized by that time you could be hitting the highest tax bracket each of those years as you divest your full tax assets. What about workers who are more likely to retire at 67-68? or later?

        Mathematically speaking, the only time the RRSP was remotely competitive with the TFSA was assuming a full re-contribution of the tax refund, and that is assuming a near 0 income retirement.

        RRSPs are like gift certificates to yourself and TFSAs are more like cash. Given the choice between giving myself a gift certificate or cash, I would take cash 100% of the time.


        • ” I did the math and found the TFSA over the very long run to be the superior savings vessel.”

          What assumptions did you make about income and taxation levels, both pre- and post-retirement? I suspect you either over-simplified your math, or you make considerably less than $50K per year. The article discussed this to some degree but the actual math can get quite complex depending on what assumptions you make.

          “Also not figured into the calculation is that an RRSP effectively forces the contributor to a 5 years de-investment period when they are 65-70.”

          How so? I plan to live to be at least 85 or 90 and expect to draw from my RRSP/RRIF in each and every year that I am retired, hoping that my RRIF will last long enough – that I don’t outlive my money. I will be supplementing my CPP and OAS with that income, and, like most Canadians, expect to be in a lower tax bracket when I retire than what I’m in now. Also, like many Canadians, I do not have a corporate or public service pension plan to rely on, so the tax deferred compounding of investment return available within an RRSP is even more critical for those of us (the majority) with that scenario, than for other Canadians. There is no such benefit from using a TFSA, which requires me to contribution almost twice as much every year in after tax dollars (given my tax bracket) to achieve the same end result I can achieve using pre-tax dollars and an RRSP.

          Sure, if I could live frugally enough now I would pay off all my debt ASAP, maximize my RRSP contributions, and maximize my TFSA as well. But the reality for most Canadians is that they cannot afford to do all three, or are not willing to do all three because they are wanting some semblance of a life now. If you make less than $50K per year, as the article points out, the two of the three goals you might choose to focus on might be paying off all debt prior to retirement while contributing to a TFSA. However, for those of us without corporate or public service pensions to look forward to, who make over $50K per year, as the article points out, the RRSP is the better choice if used responsibly.

          In my case, with a family taxable income well over $150,000, my calculations have the RRSP winning hands down. I can reduce considerably the amount of tax I pay now by contributing, I can shelter my investment income from taxation until retirement, compounding all the way, and then stream it out slowly once I’m retired, and paying less tax every year.

          Yes, it makes sense to gradually reduce the amount of risk one takes in one’s portfolio as the time horizon gets shorter; however there is absolutely no compelling reason to “de-invest” your entire portfolio until you actually need the money. Why on earth would I want to take out all my RRSP money between age 65 and 70? So I could pay more tax than I need to? What would be the point in doing that?

          The mistake too many people make is they take out large lump sum amounts from their RRSP or RRIF without considering the tax implications of doing so, rather than using the RRSP/RRIF for what it is intended for – to supplement other retirement income streams. But to do so effectively, you must do so in a tax efficient manner.

          The only scenarios I can come up with where the TFSA makes more sense than the RRSP for someone in a higher income scenario is if they will be in essentially the same or a higher tax bracket in retirement than they are in now. This might be the case for someone who has a super duper pension plan available from work, but that group is certainly in the minority.


      • At 71, you must withdrawl at a minimum of 7.34% annually. So you are guaranteed to have to pay taxes. Add on CPP and OAS, and you very easily could be in 21 -25MTR or even more. RRSP are also subject to heavy taxation upon succession. They may roll over to a spouse tax deferred, but if it goes to estate, and probate….you can take your stash and cut it in half. Your successors won’t be too happy with the realization that their inheritance was reduced by the tax man….

        Ask your self a question…do I want to pay tax now or during retirement when I am on a fixed income? Why not eliminate an entire tax scenario so you will be farther ahead in retirement?


        • I’d gladly pay you Tuesday, for a hamburger today!

          Seriously. Let me turn your question around. If you owed me twenty bucks, would you be better off to pay it to me now, or to invest it and give me the twenty bucks back in twenty years, if I was agreeable to that arrangement? Forget about rates of return for just a minute, assume you are smart enough to make a better rate of return than whatever I expect of you for this arrangement.

          Hint: there is this thing called the time value of money… besides, a lot of things can happen in twenty years.

          I will take the tax deferral each and every time, if it saves me money, which the RRSP does. If I have $100 of taxable income, and can keep $70 now, but must give $30 to the tax man, so be it. But if I have $100 of taxable income, can keep $65 now, put $15 towards my retirement, with the investment income also tax deferred, and give the taxman only $20 today, why would I not choose that latter option? I guarantee you between me and my advisors we will not let that entire $15 per $100 go to the tax man after I retire or die (disclosure: I do tax returns AND have worked as an investment advisor). In fact, it is highly unlikely the tax man will see much, if any of it.

          See, the problem for most of us is we can’t predict when we will die. If I’m unlucky enough to check out within a few weeks of retiring, then too bad for me, and my beneficiaries and the tax man will each get a piece of what is left, if my wife has either pre-deceased me or we are both unlucky and die in the same catastrophic event. What do I care? I’m gone! My kids shouldn’t be waiting around for an inheritance anyway, they should be making their own way in the world! What about my wife, you say, if I should check out early? That’s why I’ve got a will, a tax efficient estate plan, and life insurance! Oh, and by the way, neither RRSP money (with designated beneficiary) nor life insurance is subject to probate. Life insurance proceeds are not taxable (with designated beneficiary) and need not pass through the estate. Besides, at least where I live, probate is a negligible amount anyway.

          I’d rather my kids have the very first world problem of inheriting any of our left over money, after the tax man gets his cut (if there is one), than for my wife and I to have the very real world problem of either one, or both of us, being faced with the dilemma of perhaps outliving our money.

          You might want to have to go back to work when you are in your seventies (or older), but not me! Besides, what if you can’t work? What if your health is such that you can’t physically work when you are older? Or you might be healthy but you can’t find suitable work when you are older?

          Ask YOURSELF a different question. Do you want to have a tax problem, or an income problem, when you are older?

          Hint: tax problems are much easier to solve than income problems, ask any good tax advisor, or any trusted investment advisor or life insurance agent.


    • Hi Alai:
      What about the tax bill when there is no partner?
      Many believe that their children are the beneficiaries of their RRIF account when in reality the government takes close to 50%.
      I have seen couples with 300K each in the RRIF accounts, which is quite common, and having the estate pay over 250K in taxes.


  3. There are so many “if’s” & “may”s” here it’s a wonder anyone can really figure out what is best. Some statements I (who can no longer make RRSP contributions)found controversial. People who have both will have less Income – how? Both will provide. People will pay higher Taxes – HOW? RRSP fully taxed – TFSA none. RRSP great IF you need a Tax deduction. TFSA are better IF your pensions from all sources will create claw backs on some Government programs.
    The statement of RRIF withdrawal at age 67? Doesn’t this start at 71?
    One article in Money Sense was ideal, that in the event of future crashes, everyone should have 2/3 years in an emergency fund(GIC’s)the TFSA would be excellant here & not in a locked in situation – plus Tax Free.
    I really love Money Sense, talks in regular language(usually)& makes a hugh difference in one’s knowledge of finances, I learn something new with each issue.


    • People who have both will have less Income – how? Both will provide.
      – People who have a little of both RRSP and a little TFSA will have less income in the end than someone who has all RRSP (assuming all things the same and the income is >$50,000 during the contribution year.

      People will pay higher Taxes – HOW? RRSP fully taxed – TFSA none.
      – Not sure where this is from, but I’m thinking it might be in reference to paying into the TFSA with after-tax income. Say you make $200,000. Putting $5,000 into your TFSA requires about $10,000 income since you’re paying $5,000 in taxes to put that $5,000 into your TFSA. In contrast, putting $5,000 into your RRSP requires only $5,000 income since you’re not paying anything in taxes to put that $5,000 into your RRSP (assuming you deduct the contribution) – when you take that $$$ out of your RRSP, it will be at your tax rate, which will likely be lower than when you put the $$$ into the RRSP (if it is not, then it doesn’t matter but in most cases it is and that’s why this way is touted).

      TFSA are better IF your pensions from all sources will create claw backs on some Government programs.
      – This is really the wildcard of the TFSA. If this is a factor, then yes, the TFSA is the better route.

      The statement of RRIF withdrawal at age 67? Doesn’t this start at 71?
      – That’s just the age they use in their example – which is really to point out pension splitting can be done and will help with taxes, but can only be done after 65 and must be an RRIF (RRSP and 65+ age not enough – it must be an RRIF). If you convert an RRSP to an RRIF, mandatory withdrawals start the year after the conversion to an RRIF, no matter what age you are (the withdrawal % is what changes depending on your age, not the withdrawal requirement). The 71 is the longest you can have an RRSP, which does not have mandatory withdrawals. Any RRSP must be converted to an RRIF (and therefore the mandatory start) withdrawals by that age.


  4. An excellent review of the topic. And helpful to see actual income levels mentioned with regard to prioritizing RRSP or TFSA when it’s not possible to contribute to both.


  5. Great article. Nice to see some solid advice in a sea of misinformation. I’ve read so many misleading and fundamentally incorrect articles hating on RRSPs, mostly coming from lawyers for some strange reason, not a good resource for financial advice to begin with.

    This article has good examples and straight-to-the-point common sense advice. I agree with Jody’s comment as well that you max out your RRSP contributions and chuck the tax savings into a TFSA. That’s the idea scenario (assuming no high-rate debt exists).


  6. This information about income splitting the income from an RRSP after age 65 gave us the nformation we needed to make a decision to add to my husband’s RRSP and not the TFSA. A Very helpful and timely article for us.


  7. If you are 5 or more years before retirement it is far better to invest in TFSA. All the capital gains, dividends and interest will be 100 % tax free.
    All the refunds you get with RRSP will be taken all back on withdrawal Plus you will pay taxes on all capital gains. dividends and interest .
    I am retired and I see it. With my experience I would have never taken an RRSP.


    • So you think you would have been better off had you never put anything into your RRSP and paid tax all along the way?

      This would be true if you are in a higher tax bracket now than when you made the deduction, but most people’s situations are higher tax bracket while working than during retirement, in which case the RRSP saves you tax money overall, even paying taxes on the gains and dividends as income.


  8. How can you ignore the math? I agree that there are people who use their TFSA as a save / spend account and as such its not a great long term savings vehicle, for these people an RRSP that they won’t touch is a great option. By that logic putting your money under your mattress is a better option than a TFSA if you spend the TFSA and not the money under your mattress.
    When you look at the math and factor in the clawbacks and tax a TFSA is a better choice for most Canadians unless they are in the very top tax brackets.
    The math doesn’t lie, if you’ve never put a penny into a TFSA you have $36,500 of contribution room. A 45 year old who puts $36,500 into an RRSP compared to $23,811 into a TFSA ($36,500 after 34.8% tax = $23,811) will have $11,199 more money to spend at 65 by putting the money in a TFSA rather than an RRSP. That’s for someone earning $80,000 per year, if you are earning $40,000 the TFSA is even better giving you $17,668 more spendable money at age 65. It’s not until your income goes above $165,000 per year that an RRSP would give you more of an advantage. Last time I checked that was not a typical Canadian income.
    Feel free to reply with comments if you would like to see all of the calculations in more detail I’m happy to share the math.


    • What tax rate are you using on the RRSP withdrawals at 65?


  9. This question is very difficult to answer. Generally speaking, those earning under a certain amount, usually that $35,000 amount mentioned in the article are better off using a TFSA rather than an RRSP but this is why the question is difficult to answer as we are talking generalities. What happens if the person is single and can’t split income in retirement? What happens if the person will be collecting a pension and RRIF payments will put her into a higher tax bracket and reduce OAS? There are too many variables and assumptions that have to be made which will never allow this question to be answered “beyond a reasonable doubt!” I think the bigger question is to ask how can someone living in Ontario ever hope to contribute the maximum to either an RRSP or TFSA or be lucky enough to contribute to both if they are earning $50,000 with the increasing costs to live in the province?


  10. Simple RRSPs effect your government inflation indexed benefits with the possibility of causing a claw-backs, which means you are trading inflation indexed payments for NON indexed payments. The TFSA avoids this and there is NO requirement to withdraw any money at age 71. Most of the people I know who fund RRSPs do so in a tax bracket of 30%. Even average returns over 30 to 40 years will mean most will be REQUIRED to withdraw this cash in a 40% tax bracket as wel las kick in Claw-backs – so at retirement – 40% tax and claw-backs with an RRSP – while NO tax and No claw-backs with a TFSA. You may have a smaller pool of money in the TFSA but what’s better $1,000,000 taxed at 40% or $800,000 that’s all yours?.


  11. I believe that having mutiple savings plans provides the option of managing one’s incomes more effectively. OAS and GIS benefits can be impacted by RRSP and RRIF withdrawals to a greater degree than they would be by a TFSA. Also, not to be overlooked are estate planning considerations….If there is no surviving spouse for an RRSP or RRIF to roll over to, the remaining balance of the registered plan is added to your income in the year of your death…Imagine the impact of taxation of a $250K (or higher) RRSP upon death….it would be in the high 40s %….Alternativley the TFSA can be left to a beneficiary without any tax hit (only on the subsequent growth in the beneficiary’s hands) or it can rollover to a spouse….That’s a huge difference that should be factored into the decision.


  12. I have a DB pension plan, my husband is self-employed making $75,000+. Should I focus on TFSA and him on RRSP? We plan to retire in 20 yrs (60’s). Thanks!! CK- London, ON


  13. Who’s to say that the lower tax rates are not going to increase by the time someone in the 40’s retires ???
    With all levels of corrupt governments recklessly running up massive debts, all levels of tax “brackets” may need to be increased. In other words, as a percentage of income, you could be paying more income tax later than now.
    The TFSA vs RRSP debate is far from over.


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