Deposit dilemma - MoneySense

Deposit dilemma

Will the new tax-free savings account spell the end of the RRSP?


Jeff Johnson is a diligent saver. He’s only 46, but the business developer is well on his way toward a comfortable retirement. Every year he maxes out his RRSP contributions and with other investments and accounts in his portfolio he’ll have enough dough to help him live well into his golden years.

But, even with myriad investment options, the Aylmer, Que. resident is planning to open a new tax-free savings account come January. “It just makes sense that any money you have left over you put into the TFSA,” he says.

If you haven’t seen the all the ads touting the TFSA’s value, here’s a quick primer: the TFSA was introduced by the Conservative government in the last federal budget. It allows Canadians over 18 to invest up to $5,000 a year, tax-free in an investment account. Picture an RRSP without the tax implications. That means there’s no pesky capital gains and don’t worry about claiming anything on an income tax return when you withdraw your cash. The contribution room also accumulates — if you don’t save the max in 2009 you can load up the TFSA with $10,000 the next year.

It’s a great way to save and most financial institutions are already letting their clients open accounts, though contributions can’t be made until January 2. But, having a savings vehicle that’s similar to a registered savings plan begs the question — is this the end of the road for the RRSP?

For some Canucks, it is better to park hard-earned dollars in a TFSA rather than an RRSP. Robert Abboud, author of No Regrets, A Common Sense Guide to Achieving and Affording Your Life Goals, says people making $35,000 or less are better off investing in a tax-free account. “There’s a good chance that people in a lower income bracket will always be there, so I’m not sure if an RSP makes much sense anymore.”

Richard Croft, an investment advisor specializing in portfolio construction, agrees with Abboud, but adds people with pensions should also consider using a TFSA instead of an RRSP. “They should use a TFSA and call it a day,” he says. “The RRSP wouldn’t get that big a break, because they have a pension. If there’s extra money they can top up their registered savings plan.”

Another potential nail in the RRSP’s coffin is that many high income earners will continue to earn a lot of money in retirement. With more and more people counting on investment income and working part-time in their golden years, it’s possible some people’s tax brackets won’t fall as much as they think. And, a few rare folks could even bring home more money than usual.

“In a few instances, where the tax rate is higher in retirement — maybe there’s an inheritance — TFSAs will prove to be more beneficial,” explains Patricia Lovett-Reid, senior vice-president of TD Waterhouse Canada. “And, if there won’t be a marginal change in the tax rate, there’s no real difference in the two strategies.”

Clearly, there are situations where using a TFSA is better than an RRSP, but both Abboud and Lovett-Reid think it’s unlikely registered savings accounts are on their last legs. Most people who use RRSPs in their higher earning years will likely benefit when they pull the cash out of their account during retirement. Abboud explains: “If someone is depositing $1,000 today and getting back $460 and later on, when they take out $1,000 and only pay $230, they win. They win by 23%.”

“Financially, they just make sense,” adds Lovett-Reid. “For those looking to put more money back in their pocket, and if they’re going to spend a lot of time in retirement, it’s great. I can’t imagine RRSPs going out of vogue.”

Johnson doesn’t plan on cutting back his RRSP payments after he opens a TFSA. Like the majority of people who will set up an account, he plans to use the contribution room to save extra money that he can pull out without penalty if need be. “I don’t see it as being a huge part of my portfolio,” he says. “I keep money on the side for emergencies, so it would make sense to put that in a TFSA.”

Others might decide to use their new account as way to save for short-term goals, like a vacation or a new car. Either way Lovett-Reid is just happy people have another option to save. With only 7% of Canadians topping up their RRSP room, if there’s another incentive for Canadians to hang on to their money, that’s a good thing. “In a perfect world people would maximize their RRSPs and they’d put their extra money in a TFSA,” she says. “But really, I just want people to save.”