My latest MoneySense blog is a followup to an interesting piece by actuary Fred Vettese about the curious phenomenon of wealthy couples being able to contort their finances between ages 67 and 70, by which they can receive the Guaranteed Income Supplement or GIS.
Considering that the GIS is aimed at seniors with no savings and minimal pensions, the idea of putting such a gambit in place offends some, although as the blog points out, most of the readers who contacted Vettese just wanted more details on how they could benefit from the strategy themselves.
Hypothetical but max out your TFSA while you can
I’ll be doing more on this but it seems that the strategy is not so much likely to become widespread as it is an example of the inherent contradictions and unintended consequences that accompany such a proliferation of government programs. This one is based on suspending most sources of income from 67 to 70, except Old Age Security (OAS) and the GIS, plus taking tax-free income from the Tax Free Savings Account or TFSA. TFSA withdrawals are neither taxed nor trigger clawbacks of OAS and GIS. In fact, it’s arguable TFSAs were created expressly to motivate low-income workers to save without being penalized by the taxes and clawbacks that accompany RRSPs and employer-sponsored pensions plans.
Will Ottawa move to crack down on this theoretical loophole? Who knows but the TFSA was the Conservative administration’s creation and if they lose the next election, it’s quite possible the Liberals or NDP would move to tweak either the TFSA rules or the GIS qualifying rules. Best advice? Max out the TFSA while you still can!
My take on a C.D. Howe brief issued Thursday on the case for raising RRSP contribution limits can be found in my Financial Post column today here. Also note the many comments that follow the piece, some reflective of the emails I will highlight in Friday’s blog. You can find the full e-brief here.
And in case it’s not clear in the column, I absolutely think this is a good idea: always have. It’s true those with lower incomes may not need RRSPs. TFSAs may be a better solution for them, especially if they want to avoid clawbacks of OAS or GIS in old age. But the vast majority in the middle class who lack employer pension plans (especially the lucrative DB plans) could benefit from higher limits. If, as is likely, they will retire in a lower tax bracket than they were in their high-earning years, then an RRSP is almost a necessity. And as I point out in the piece, since only a minority of Canadians are in a position to max out their RRSPs, it shouldn’t cost Ottawa all that much because of more upfront tax deductions. And unlike the TFSA, which will reap no bonanza for federal coffers on withdrawals, RRIF income will eventually bring in lots of tax revenue for the government once we retire.
Seems like a win-win to me. Stay tuned for more reader feedback tomorrow.
A belated Happy New Year to all readers and a reminder that every adult Canadian can take a big step this week towards their ultimate financial independence. I refer of course to the fact we can all contribute another $5,500 to our Tax Free Savings Accounts (TFSAs), bringing the total cumulative room to $25,500 (going back to the program’s launch in 2009). For the benefit of any American readers, Canada’s TFSA is the equivalent of the U.S. Roth plans, albeit with different rules.
In other words, if you acted at this time each year, you’d have contributed $5,000 in each of 2009, 2010, 2011 and 2012. Now that it’s 2013, the annual limit has been raised to $5,500, the first time the limit has been adjusted to accommodate inflation.
Of course, assuming you invested wisely in each of those years, your balance should by now be well north of $25,500, and in some cases may have grown past $30,000.
TFSAs a particular boon for young people
I truly believe that maximizing the TFSA is the single biggest step Canadians can take in their quest for financial freedom. As we noted in Julie Cazzin’s “Make Your Child a Millionaire” feature in the current issue of MoneySense, the TFSA is especially a boon to young people because they have such a long investment time horizon ahead of them.
Unlike RRSPs, which require earned income the prior year, an 18 year old can qualify for the full TFSA $5,500 limit this year (they may need parental assistance to come up with the money, but that’s permitted by the rules. Think of it as a tax-effective early inheritance!). Not only that, but they can contribute to TFSAs well into old age, unlike RRSPs, which end after age 71. You better believe that half a century of maximizing TFSAs and investing wisely will mean multi-millions down the road.
Do this right from the get-go and you may not even have to worry about RRSP contributions, although those in higher tax brackets should probably do both.
But how to invest wisely? For the young in particular, but also older people seeking income, I think equities are the only way to go in TFSAs, especially with interest rates being so low as they are now.
I’m all for international investing but if you already have lots of RRSP contribution room, I’d use the RRSP for US dividend-paying stocks, since the tax treaty shelters Canadians from the 15% foreign withholding tax.
Despite the “tax-free” moniker, TFSAs won’t stop you from being dinged by that tax on foreign securities. For this reason, I like TFSAs for Canadian dividend-paying stocks. Yes, I realize the dividend tax credit makes Canadian dividends a good choice for non-registered (taxable) accounts, since the tax is roughly half what it is on interest income. However, Canadian dividends also result in the annoying “gross-up” calculation come tax-time, and such phantom dividend income can ultimately hurt you on the OAS clawback. And to me, zero tax is preferable to even a “low” rate of tax, especially if you plan to reinvest those dividends.
Canadian Dividend ETFs are my choice
For all these reasons, my personal choice for TFSAs this year are Canadian dividend-paying ETFs. A year ago, when it was part of the Claymore family, I publicly stated that the iShares S&P/TSX Canadian Dividend Aristocrats Index Fund (CDZ/TSX) was a tempting choice, at least for those who already have plenty of exposure to the big Canadian banks. To be included in that index a stock has to be a common stock or income trust listed on the TSE and have increased dividends for at least five consecutive years.
This year, there is a valid new alternative from Vanguard Canada: the Vanguard FTSE Canadian High Dividend Yield Index ETF (VDY/TSX). The management fee on VDY is just 0.30%, half the 0.60% of CDZ. (MER is 0.67%, we don’t yet know what VDY’s MER will be). But keep in mind that VDY amounts to a big bet on the major banks: a whopping 59% of the ETF is in Canadian financials and in fact the top four holdings are all the big banks. CDZ has much less exposure to financials (just 21%) and minimal exposure to the big six banks in particular.
Half and half is one compromise
One way to go might be to split your contribution between both ETFs: say $2,750 in each. Remember, though, this assumes you have plenty of US and foreign stock exposure in your RRSP. Younger people for whom the TFSA comprises the lion’s share of their wealth should strive for plenty of US and foreign stock exposure through similar types of ETFs. We’ll be looking in depth at these in the next issue of MoneySense, currently in production.