TFSA vs RRSP: How seniors can use TFSAs to have more in retirement

Because the biggest single expense in retirement is usually tax, high-income seniors should strive to use Tax-free Savings Accounts (TFSA) to minimize the tax bite in their later years.

The key is to maximize both contributions and growth no matter how old you are, which means holding proper growth investments (equities) instead of fixed-income instruments that pay a pittance.

“The TFSA is a mis-named vehicle,” says T.E. Wealth’s senior vice president Warren Baldwin, who prefers the term “Tax-free Portfolio Account” or TFPA. Still, it’s fortunate that despite the misnomer, the TFSA can act as a TFPA.

Because the TFSA was introduced only in 2009, most seniors have ten times as much money in RRSPs and RRIFs than TFSAs, says Sandy Aitken, CEO of M-Link Mortgage Corp, developer of TFSA Maximizer. Over 15 years, his product aims to reverse that ratio.

The main issue is when RRSPs convert to RRIFs after age 71 (if not annuitized) and the legislated annual minimum withdrawals that require them to pay income tax at high marginal tax rates.

Why is the TFSA so valuable to seniors? Unlike RRIFs, TFSAs generate no taxable income on withdrawals nor investment income. But TFSAs are equally a boon to the less fortunate: they don’t trigger clawbacks of Old Age Security or the Guaranteed Income Supplement.

Another big difference is that unlike RRSPs and RRIFs you can keep contributing new money into TFSAs after age 71. Even if you live to celebrate your 101^st birthday – as my friend Meta recently did – you can continue to pump in $5,500 a year to your TFSA, as Meta has been doing.

In contrast, you can no longer contribute to RRSPs after the year you turn 71 (or after the year the youngest spouse turns 71), and even then this depends on either carrying forward RRSP room or earning new income. As Baldwin notes, most seniors have little or no earned income. Nor can they contribute new money to RRIFs: they’re strictly vehicles that shelter what you’ve got until the next forced annual withdrawal, which escalates over time from 5.28% at 71 to 20% a year once you reach 95.

Baldwin says some retirees should start their RRIFs by age 64 or 65 in order to claim the Pension credit. Plus it may make sense to “grind down” RRSP/RRIF values well before age 71 if you find yourself in lower tax brackets.

It would be nice if you could magically transform your RRSP/RRIF into a TFSA in an instant. In reality, the process will take a decade or more. “TFSAs are an excellent vehicle for those in or near retirement,” says Matthew Ardrey, wealth advisor and vice president of Toronto-based TriDelta Financial. TFSAs “can be a considerable advantage over the RRSP/RRIF.”

Ardrey provides the example of the purchase of a big-ticket item like a $40,000 new car. If all a senior couple have is an RRSP or RRIF, they’ll need to withdraw almost double the purchase price to get the same after-tax amount that taking $40,000 tax-free from their TFSA(s) would furnish. But withdrawing $80,000 from RRSPs may put their income above the threshold for OAS clawbacks. In 2018, this threshold is $75,910, after which the OAS Recovery Tax results in a 15% clawback of OAS income for every dollar over the threshold.

But what if you can’t afford a car? Ardrey points out the TFSA is even more important for GIS recipients than for OAS because every dollar of taxable income reduces GIS by 50 cents. (OAS and GIS income don’t trigger GIS clawbacks nor does the first $3,500 of employment income).

So TFSAs makes sense for all seniors, rich or poor. This is why Ardrey urges every retiree to maximize TFSA contribution every year: to the current limit of $5,500 a year, plus any future inflation adjustments.

To maximize the time value of money, it’s best to contribute early in January 2018 and every subsequent January. On the flip side, Baldwin says TFSA withdrawals should be deferred as late as possible in the calendar year. This minimizes the time before you can re-contribute to the plan.

But once your working years are over, how can seniors come up with the money for TFSA contributions? There are two primary ways. First are those forced RRIF withdrawals. You must pay the tax on withdrawals but don’t have to spend the proceeds. Assuming that minimum RRIF payments and other income sources exceed spending needs, those net (after tax) withdrawals can go into your TFSA.

Secondly, many seniors have a lot of wealth in non-registered investments (RRSP room may have been limited, perhaps because of a high Pension Adjustment created by generous DB pension plans.)

Fortunately, you don’t need “new money” to make TFSA contributions in your golden years. Aim to gradually “convert” your taxable accounts into TFSA accounts, $5,500 a year for each spouse. Ardrey notes one spouse can fund the entire $11,000 a year available for a couple, as there is no attribution on TFSA contributions.

You can make TFSA “transfers-in-kind” from non-registered accounts: easily accomplished by talking to your financial institution. Best case is to have a security priced roughly where you originally bought it: then you could transfer-in-kind $5,500 worth of that stock into your TFSA with minimal tax consequences.

However, odds are you DO have some capital gains in your open account, in which case you’ll have to take a one-time tax hit. But you may be able to mitigate the tax if you can find some capital losses to offset winners. Ardrey says any non-registered investments transferred into the TFSA are considered deemed dispositions: any gains will be realized; so will capital losses but they can’t be used for tax purposes to offset any current or past losses. In order to crystalize losses, the security must be sold on the market (or redeemed if a mutual fund), then the cash proceeds can be contributed. Keep in mind you can’t repurchase the security in the following 30 days, in order to avoid the superficial loss rules.

Ideally, TFSAs should be the last retirement income source seniors should tap. Purely from a tax perspective, you want to draw down on RRIFs and non-registered accounts first, says Doug Dahmer, founder of Burlington-Ont.-based Emeritus Financial Strategies. Ardrey says after being forced to withdraw your RRIF minimums, you should review your tax situation to see where you should take your next dollar of income.

“As long as there is inescapable tax tied up in your investment portfolios you want to pay these taxes while you alive,” Dahmer says. It’s probable you’ll be in a lower marginal tax bracket while still alive, so can income-split. If you wait until one spouse dies, the survivor’s combined holdings will push them into a much higher tax bracket: Dahmer terms this a “tax trap.”

Tax brackets matter. Baldwin says if you have embedded capital gains and some room in the lower or middle marginal tax brackets, it may make sense to draw on the RRSP/RRIF first since they will be eventually 100% taxable when eventually forced to withdraw; by contrast, capital gains are only 50% taxable, or not at all if donated to charity.

Dahmer’s clients call their TFSAs their “Never Never Fund.” While available for emergencies, they should be the last source of funds to be tapped. This flies in the face of the banks’ depiction of TFSAs as “save to spend” accounts holding low-yielding daily-interest savings accounts. By contrast, Dahmer says TFSA time horizons should be aimed at those likely to inherit the money, which means healthy exposure to equities.

TFSAs can also serve as highly cost-efficient form of estate planning to supplement the use of Whole Life or Universal Life insurance policies. And remember that while both spouses are alive, they should designate each other the TFSA’s successor holder. This way, the survivor can transfer the value of the TFSA at death, plus any growth after death, into the survivor’s TFSA with no tax implications.

If funding is short, you should always top up the TFSA of the spouse who is likely to die first because the survivor can top up later, Dahmer says. “Downsizing your house is also a wonderful time to top up your TFSA.”

Jonathan Chevreau is founder of the Financial Independence Hub and co-author of Victory Lap Retirement. He can be reached at [email protected]

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About Jonathan Chevreau

As MoneySense’s Investing-Editor-at-Large, he is also author of Findependence Day and co-author of Victory Lap Retirement. Reach him at [email protected], where he is the founder of Financial Independence Hub.