Is a TFSA always worthwhile?

[Shakespeare]

Although I would not pay unneeded tax now on non-registered money unless the future tax liability was greater, that future liability needs to be discounted to the present value.

[newguy]

Maybe I shouldn't of used an inequality. If you use an equality and assume your marginal rates are the same, you will have the same amount of money (after tax) in the future in either strategy.

I don't get why you would discount the future tax liability unless you plan on investing in different products. I assumed you would re-buy the same security.

newguy

[northbeach]

Can't quite follow the last few posts, but in my case I do hold a small amount of interest bearing income in my margin account.

This has occurred since I moved to a 65% fixed income/cash - 35% equity portfolio.

[Shakespeare]

I don't get why you would discount the future tax liability

Why would I pay, say, $1K in tax today when I don't need to? If I don't need to pay it until next year, deferring the tax has to be worth something.

[newguy]

I don't get why you would discount the future tax liability

Why would I pay, say, $1K in tax today when I don't need to? If I don't need to pay it until next year, deferring the tax has to be worth something.

Of course you're right, the deferred tax would be worth exactly as much as that which you'd not have to pay on the tax free growth in the tfsa.

As your investment grows your tax liability grows in the non. reg. account. It will stop growing once you move it to the tfsa.

newguy

[newguy]

Actually you're making me redo my calculations because they're not exact due to the fact that any cap. gains. have a cost base that needs to be subtracted. It seems that it is always better to move to a tfsa. Will post later becuase I'm major short today.

newguy

[newguy]

Ok, the math for adding cost base and different marg. rates is very confusing to read so here is a little spreadsheet. Unless growth is negative or your marg. rate drops big time the tfsa will always win. Notice if the cost base is 0 and the marginal rates don't change then they are always the same.

[Springbok]

Seems like you guys are getting a bit carried away over a $5k investment.

[newguy]

Seems like you guys are getting a bit carried away over a $5k investment.

But multiply that times a spouse and the next 10 years* and it's over 100k.

newguy

* shakespeare, don't worry, I'm not prescient.

[Springbok]

Seems like you guys are getting a bit carried away over a $5k investment.

But multiply that times a spouse and the next 10 years* and it's over 100k.

newguy

* shakespeare, don't worry, I'm not prescient.

OK then,

Seems like you guys are getting a bit carried away over a $5kpa investment.

[Mouly]

The TFSA is better if:

(final marg tax rate - initial marg tax rate) * initial prin

is greater than

(final marg tax rate / (1 +percentage growth of investment) - initial marg tax rate) * ACB


that leads to three situations to consider, your marginal tax rate either goes up, down, or remains unchanged. The first two cases lead to messy formulas where you compare the ratio of prin/ACB to a function of the two tax rates and the investment return. In the case where tax rates do not change then TFSA is better in any case where return is positive.

[newguy]

So lets just say that moving from rrsp -> tfsa is only tax arbitrage and you need a higher future rate.
Moving from non. reg. -> tfsa will almost always make money unless you're in a much higher tax bracket right now.
If you will move something from non. reg. -> tfsa, then pick the security with the highest cost base to minimize tax paid now.

newguy

[marty123]

Seems like you guys are getting a bit carried away over a $5kpa investment.

For a couple making $90,000 (twice the YMPE), a TFSA makes up 40% of the registered contribution room being added every year. $5kpa far exceeds what the average Canadian sets aside for retirement every year. Two young adults today could have as much as $250,000 + inflation in countribution room by the time they reach 40.

For someone with an existing 6- or 7-digit portfolio, the $5kpa contribution room may only make a marginal difference. For others that are in withdrawal mode and spend 100%+ of their retirement income, it may have no value. However, I think it's unfair to tell people to ignore the benefits of the TFSA.

[steves]

[My two cents]

Anyone using a spreadsheet to make these determinations might want to consider...

There is no such thing as the marginal tax rate. This is an approximation used by spreadsheet programmers to account for the effect of income tax. There is something called 'tax', which is a complex algorithm with tax brackets, thresholds, clawbacks, age deductions... etc, several of which are indexed to inflation.

Examining the effect on a plan (retirement or estate) of taking various investment paths (RRSP, TFSA, other) without acknowledging the complex, time related effect of the income tax formulation could be a mistake.

[/my two cents]

[Springbok]

Seems like you guys are getting a bit carried away over a $5kpa investment.

For a couple making $90,000 (twice the YMPE), a TFSA makes up 40% of the registered contribution room being added every year. $5kpa far exceeds what the average Canadian sets aside for retirement every year. Two young adults today could have as much as $250,000 + inflation in countribution room by the time they reach 40.

For someone with an existing 6- or 7-digit portfolio, the $5kpa contribution room may only make a marginal difference. For others that are in withdrawal mode and spend 100%+ of their retirement income, it may have no value. However, I think it's unfair to tell people to ignore the benefits of the TFSA.

I totally agree Marty!

I was really just commenting on the higher math that was going on

My kids are using TFSAs and so are we.

We are between retirement and RRIF withdrawal. For us, this is a low tax period, partly because of the way our unregistered portfolio is structured (no FI, mainly Divs and ROC). Once RRIFs kick in, we won't be able to avoid paying higher taxes.

We are using this low tax period to voluntarily withdraw from RRIFs we set up for the purpose. The withdrawals will in part go into our TFSAs.

But everyone has their own situation and should act accordingly.

[cardhu]

There is no higher math required ... this is a very simple problem ... it is merely the reverse of the more commonly discussed accumulation -phase RRSP scenario in which the tax amounts exactly cancel each other out when tax rates are equal at contribution and withdrawal... in this case, you’re looking at the tax rates between two future withdrawal dates, but the same principles apply.

Funds for the TFSA can not be found without either paying CG tax on non-registered funds or paying income tax on RRSP/LIF withdrawals.

A case of the tax tail wagging the investment dog, perhaps?

In both cases (RRSP shuffle & non-reg shuffle) you have an unknown future tax liability, that you’re measuring against a known current tax liability ... it is that relationship that determines the outcome ... if you think your future tax rate will be lower than your current rate (substantially lower in the case of non-reg assets) then it may make sense to defer the tax ... but if you are already retired, what are the chances of that? ... any amount diverted now will reduce your eventual RRIF withdrawals, and will mostly likely also reduce the amount of RRSP liquidated (or cap gain realized) in your year of death ... if you have only a small portfolio to begin with, that amount may turn out to be negligible ... but if you have substantial RRSP or non-reg assets, it may be somewhere north of negligible.

Why would I pay, say, $1K in tax today when I don't need to? If I don't need to pay it until next year, deferring the tax has to be worth something.

That “worth” is an illusion.

For a shuffle from RRSP to TFSA, deferring the tax is exactly neutral, unless the tax rate changes ... the tax rate differential is the critical variable ... you are already retired, and already enjoying a low tax rate ... if you expect your tax rate in future to be even lower than it is now, then you are right to delay the taxable event ... but if there’s a possibility of paying a higher rate in future (say in your year of death), then paying the tax now would be the better choice ... paying the same rate in the future would be a neutral choice ... neither better nor worse.

The issue of whether you pay those taxes in 2009 dollars or 2019 dollars is an irrelevant distraction ... it is the tax rates that determine the outcome.

The case for a shuffle of non-reg assets into TFSA is a little different ... the ACB would remain static, while the asset continues to grow, and that causes the nominal tax liability to grow faster than the overall rate of return ... in that case, with tax rates equal now and in the future, the TFSA wins hands down, on a pure cap gain basis (ie. no dividends) ... your tax rate could be slightly lower in the future, and you’d STILL be better off making the shuffle now ... it’d have to be substantially lower in the future, to make deferring the tax worthwhile.

Again, the issue of whether you pay those taxes in 2009 or 2019 dollars has no bearing.

The argument in favour of delaying RRSP/RRIF draws until forced to withdraw by the RRIF schedule is flawed in general, and especially so if you have TFSA space available that you have no other use for ... on the other hand, it would appear to be more beneficial to shuffle non-reg equities than RRSP assets, if you have ‘em.

* (The one significant exception to these scenarios, is where your future returns are negative ... nominal returns, not real returns ... in that case, you’d have been better off leaving the assets as is)

I don't have a TFSA. I've though about it, but it never seemed to me like such a compelling idea.

Accrued capital gains and RRSP balances become taxable in your year of death (or your spouse's, whichever comes last) ... TFSA balances do not ... that may be the most compelling argument in favour of TFSA for a case like yours ... shuffling assets that have significant embedded gains can appear to be a problem, but as shown above, that can be a case of the tail wagging the dog ... perhaps there will be circumstances (March of 2009 comes to mind) where embedded but unrealized capital gains evaporate temporarily, providing an opportunity to shuffle things around with negligible (if any) current tax implications (ie. effectively “crystallizing” the reduced tax liabilities).

Canadian stocks? No. US stocks? No. There's better places for both based on tax treatment.

Agree wrt US stocks ... on Cdn stocks, I can see not wanting to put dividends that are taxed at a negative marginal rate into TFSA ... however, the era of significantly negative marginal rates for dividends is coming to a close ... by 2012, the marginal rate for dividends in the lowest ON bracket will be -0.5% ... a far cry from the -7.7% this year ... when that happens, TFSA would be a better place than an unregistered account, to hold Cdn stocks, based on tax treatment, for ANY stock in which the overall return is some combination of capital gains and dividends.

they don't offer TFSA's in USD, do they?

Questrade does, at present ... I hope the others will eventually follow suit.


Probably the best value would be had by first shuffling those non-reg assets that have the highest ACB as a percentage of current value (while being careful to avoid disqualification of cap losses), then those with a lower ACB vs current value, and finally RRSP assets.

One final thought ... these conclusions all hinge on the availability of TFSA space that is not otherwise spoken for ... so none of this applies to someone who is, for example, using their TFSA for interest-bearing emergency fund, or any of that sort of thing.

[agraham]

Why would I pay, say, $1K in tax today when I don't need to? If I don't need to pay it until next year, deferring the tax has to be worth something.

That “worth” is an illusion.

For a shuffle from RRSP to TFSA, deferring the tax is exactly neutral, unless the tax rate changes ... paying the same rate in the future would be a neutral choice ... neither better nor worse.

The issue of whether you pay those taxes in 2009 dollars or 2019 dollars is an irrelevant distraction ... it is the tax rates that determine the outcome.

But what about the time value of money? Isn't it true that if I could forgo paying a chunk of change for ten years I get what amounts to an interest free investment loan from the taxman?

[Shakespeare]

But what about the time value of money? Isn't it true that if I could forgo paying a chunk of change for ten years I get what amounts to an interest free investment loan from the taxman?

There is also the effect of indexation on the tax brackets.

[steves]

As well as the various age credits/exemptions that kick in after 65.

The 'use the TFSA for lump sum emergency cash draws' makes sense if those emergency situations actually crop up. However, if you have invested outside your RRSP in a TFSA for the reason that you expect those lump sum emergencies will occur, and then they don't.... well guess what? you will have disadvantaged your plan. It is a really tricky determination.

My fiddling indicates that for the average Joe forecasting to deliver a constant (no surprises) after tax/inflation income out to a reasonable age (85-90-95), then it makes sense to max your rrsp.

If you don't expect to make it to that ripe old age, then your estate will have benefited by the TFSA strategy. (that is, if you care about estate issues)

This is not a simple determination.

[travesty]

Why would I pay, say, $1K in tax today when I don't need to? If I don't need to pay it until next year, deferring the tax has to be worth something.

That “worth” is an illusion.

For a shuffle from RRSP to TFSA, deferring the tax is exactly neutral, unless the tax rate changes ... paying the same rate in the future would be a neutral choice ... neither better nor worse.

The issue of whether you pay those taxes in 2009 dollars or 2019 dollars is an irrelevant distraction ... it is the tax rates that determine the outcome.

But what about the time value of money? Isn't it true that if I could forgo paying a chunk of change for ten years I get what amounts to an interest free investment loan from the taxman?

No, the calculation implicitly takes into account the time value of money - in fact you have the same "net" assets throughout in both strategies. Another way of looking at it is that the deferring the tax (tax-free "loan") means you pay more tax in nominal dollars in the end, which cancels out the effect of the "loan".

The math is pretty straightforward - let M be some amount in an RRSP for which you are considering an RRSP->TFSA shuffle, and t1 be your marginal tax rate at the time of the shuffle and t2 at the time of consumption, and r be your total rate of return in the period between the shuffle and consumption (this rate could be nominal or real, the result will be in nominal or real dollars depending on your choice):

After tax dollars at consumption time available using "keep it in the RRSP" strategy:

capital in RRSP * rate of total return * (1 - tax rate at withdrawal)

M * r * (1 - t2)

After tax dollars at consumption time available using "shuffle it to the TFSA and withdraw it later, tax free" strategy:

capital in the RRSP * (1 - MTR at time of shuffle) * r

M * (1 - t1) * r

Note that multiplication is commutative and associative and the formulas are thus identical if t1 is equal to t2, as cardhu points out. Note that there is no need to discount anything here by the time value of money, etc - it is implicitly accounted for already in the rate r (if you so wish).

[cardhu]

But what about the time value of money? Isn't it true that if I could forgo paying a chunk of change for ten years I get what amounts to an interest free investment loan from the taxman?

Inflation affects the RRSP and TFSA equally, so the effect is transparent … $9,000 in 2024 is exactly equal to $9,000 in 2024* … inflation will affect how many loaves of bread that $9,000 will buy, of course, but it does not and cannot make the first $9,000 worth any more or any less than the second $9,000 … they remain identically valued, regardless of inflation.

* the former number ($9,000 in 2024) is the future after-tax value of $5,000 left to grow in the RRSP, for 15 years at 6%p.a., then withdrawn and exposed to a 25% tax rate.
* the latter number ($9,000 in 2024) is the future after-tax value of $5,000 withdrawn from RRSP today, subjected to a 25% tax rate, then placed in TFSA to grow for 15 years at 6% p.a.

There is also the effect of indexation on the tax brackets.

Which can produce a lower future tax rate ONLY if your retirement income steadily declines, in real terms ... in which case, as I mentioned above, if your future tax rate will be substantially lower than the present tax rate, the shuffle isn't advantageous ... if your income keeps pace with inflation, even roughly, that indexing of brackets is irrelevant to this discussion.

As well as the various age credits/exemptions that kick in after 65.

There are also various other sources of income that kick in after age 65, not to mention after age 71. The only tax of interest here is the tax attributable to those future RRSP withdrawals, or future non-reg liquidations, and my calcs indicate that those rates will not change substantially, in a “typical” case … in my own case, they’ll increase slightly, at age 65.

My fiddling indicates that for the average Joe forecasting to deliver a constant (no surprises) after tax/inflation income out to a reasonable age (85-90-95), then it makes sense to max your rrsp.

Yabbut, that is not the question that was asked … Shakespeare is already retired … he is past his contribution years, and is drawing from his portfolio … maxing his RRSP is not in the cards … there are only two ways he can benefit by not shuffling assets into TFSA … well, maybe three …
1. if his future tax rate is lower than his current tax rate (substantially lower in the case of a non-reg shuffle into TFSA).
2. if his future investment returns are deeply negative … (because unlike non-reg and RRSP, he cannot benefit from those losses if they occur in a TFSA)
3. if the assets pay substantial eligible dividends, and future governments amend the tax rules such that dividends are taxed negatively in his bracket.

It is a very simple determination, in the context of the question that was asked, and in the case of a shuffle from RRSP to TFSA ... the case of a non-reg shuffle is slightly less simple, because ACB enters the equation, but it is quite a bit more advantageous, in that the future tax rate has to be substantially lower, in order for the don't-shuffle approach to come out ahead.

[par4]

Am I missing something here. All my grandchildren have set up TFSA's The plan was to put the max 5M in and then draw it out for tuition. Repeating this until they finished Univ. At the end of 4 years would they not have contribution room 0f 20M? i.e. if they inherited money they would have a place to put it in a tax-sheltered account.

[Clock Watcher]

I am questioning whether the inability to get the highest yield can offset the tax benefits of a TFSA. Currently my TFSA is paying 1.05% at ING. If I am not in a TFSA, I can simply transfer to Ally which is paying 2%. It seems to me that 2% after tax is still better than 1.05% tax-free.

[Caleo]

Thank you very much, Cardhu, for your time and effort in explaining your logic regarding how to use TFSA room while in withdrawal phase (retirement). After months of debating the issue in my mind, you have confirmed my conclusions, I think.

With about 80% registered funds, 20% non-registered, no work pensions, collecting CPP but not OAS yet, we are in the lowest tax bracket now. But could be higher when OAS kicks in and even higher when mandatory RSP withdrawals are in effect. So my thought was to deregister more funds than necessary during these years, leaving extra in nonregistered dividend stocks. When the TFSA was added to the mix, I decided to increase the RSP withdrawal to deposit there. As this doesn't (shouldn't) increase our tax bracket, it seems logical to me. Taxes are inevitable. We just want to keep them minimal for us and our heirs. Does this make any sense?

[travesty]

I am questioning whether the inability to get the highest yield can offset the tax benefits of a TFSA. Currently my TFSA is paying 1.05% at ING. If I am not in a TFSA, I can simply transfer to Ally which is paying 2%. It seems to me that 2% after tax is still better than 1.05% tax-free.

Yes, in some limited cases it may be that some particular class of investments available outside of the TFSA are substantially better than equivalents inside - and high interest savings accounts appears fall into this category at this time, although I do not expect this to last.

Most other frequently used individual-investor assets are relatively equally available inside TFSAs, however, since the places where you'd invest in these offer TFSAs capable of holding them.

Interactive Brokers is another example of a downside of the TFSA - they do not offer them, but I cannot get comparable margin or FX rates anywhere else that does (I will still fill my TFSA, at another broker).