RSP: last minute thoughts

[steve41]

Now that RRSP season is just about over, I thought it would be useful to look at the RRSP as a retirement savings vehicle as compared to other options.

Imagine our hero is 45, single, has his life in order (loans paid off, career established), but has just $10,000 in his RRSP. So, now he decides to plan the rest of his life... i.e. save for retirement in earnest.

His salary is $65K gross, he expects it to be indexed to inflation and plans to retire at 65.

He chooses 3 investment strategies:
1. max his RRSP (additional investment going to his TFSA)
2. invest fully in a tax-free savings account
3. invest in non-reg (taxed as 50% divs, 50% capgains)
4. same as #3, but taxed as interest

(rate of investment growth 5%, inflation 2%, living in BC, full CPP and OAS expectation)

Based on living the same constant ATI (lifestyle) of $36000, which strategy will sustain that $36K lifestyle the longest?

Answer....
#1 takes him to age 101 (http://www.fimetrics.com/number-1.pdf)
#2 takes him to age 101 (http://www.fimetrics.com/number-2.pdf)
#3 takes him to age 93 (http://www.fimetrics.com/number-3.pdf)
#4 takes him to age 86 (http://www.fimetrics.com/number-4.pdf)

The notable thing about this calculation is that the effect of taxation is not approximated in the way that is normally done by financial commentators (i.e. using average, marginal or METR rates before/after retirement)

This calculation invokes the full and complete T1 calculation (over time).... fed&prov rates, age credits, clawbacks, deductions, and (especially!!) it indexes the tax brackets. Unlike the (usual) spreadsheet approach which uses approximated tax rates, this calculation stands up to full tax scrutiny.

The only simplification was to remove the $5000 contribution limit to the TFSA.

So, if you are hesitating about making that last minute stop at your bank before the deadline.....

[the-royal-mail]

Question: do options 1 and 2 both assume same clawbacks OAS, GIS etc? IIRC the clawbacks only apply to RRSPs?

FWIW I won't be contributing to my RRSP (tier 3) this year. Tier 2 needs at least one more year of attention before I can go to tier 3.

[lost_investor]

Wow, thanks for the charts and neat software.

I was thinking that at age 45 he would have built up a bit of unused RRSP deduction limit which he direct his additional investment into but I'm not sure if that really changes things.

I'm feeling better about maxing out my RRSPs.

[steve41]

Question: do options 1 and 2 both assume same clawbacks OAS, GIS etc? IIRC the clawbacks only apply to RRSPs?

FWIW I won't be contributing to my RRSP (tier 3) this year. Tier 2 needs at least one more year of attention before I can go to tier 3.

No the clawbacks (GIS in this case) are different for each case 1&2.

[OhGreatGuru]

...


The only simplification was to remove the $5000 contribution limit to the TFSA.
....

A rather gross assumption, considering his annual RRSP room is about twice the annual TFSA limit.

[steve41]

A rather gross assumption, considering his annual RRSP room is about twice the annual TFSA limit.

I did it to make the results more readable. I could have included the actual allowable TFSA limits, but it would have trivialized the effect of the TFSA over that short 20 year span. The point I was trying to make was that even if the TFSA were to be opened up with no contrib limits, the RRSP and TFSA would still be equivalent. (BTW, by 'equivalent' I mean as a retirement savings vehicle, not as a lump sum emergency fund vehicle)

Another thing to take note of.... "non-taxable income" in #1 and #2. That column represents GIS income, and it is much higher in the TFSA (#2) scenario. I could envisage the feds changing the rules in the future and including TFSA income in the GIS calc. That would give the RRSP quite an edge.

[HaroldCrump]

I could envisage the feds changing the rules in the future and including TFSA income in the GIS calc. That would give the RRSP quite an edge.Inspite of all my anti-tax ramblings, I'd be supportive of a move like that.
I don't think it's fair to let someone claim GIS when they may be earning hundreds of thousands from a TFSA account, say several years/decades from now.
That would be a good problem to have, IMO, and everyone should be that fortunate.

[the-royal-mail]

Ugh - sorry Harold, it had to happen one of these years, but I'll have to disagree with you on that last post. The intention behind the TFSA was to encourage CDNs to save more. I am unclear about what the % utilization is, of this type of account on a maxed-out basis, but if I've been smart enough to save that much money through my life (which would have otherwise been in my mattress) then I should by extension, be reaping the benefits of my money and savings foresight. Also remember this was given to CDNs as part of a package of tax cuts that included cuts to the GST.

[steve41]

OK, so I am Minister of Finance, faced with a need to increase revenues. What newspaper headline would be more palatable?....

"Feds Raise Personal Income Tax Rates" or "TFSA Income to be included GIS determination"

Most people wouldn't have a clue what the latter headline meant. (present company excepted)

[HaroldCrump]

Ugh - sorry Harold, it had to happen one of these years, but I'll have to disagree with you on that last post. The intention behind the TFSA was to encourage CDNs to save more. I am unclear about what the % utilization is, of this type of account on a maxed-out basis, but if I've been smart enough to save that much money through my life (which would have otherwise been in my mattress) then I should by extension, be reaping the benefits of my money and savings foresight. Also remember this was given to CDNs as part of a package of tax cuts that included cuts to the GST.I don't think we are disagreeing.
GIS is pure welfare and is paid out of general tax revenues of the govt., contributed by the currently working generation.
How would you feel if the taxes from your hard earned money went to some dude who had a $1M portfolio inside his TFSA and generated 10% a year in income (i.e. $100,000)?
If the $100,000 doesn't count against GIS eligibility, this person would get max GIS and max OAS i.e. laugh all the way to the bank every month - I don't think that's fair.
It will simply create a generation of "poor millionaires".

To clarify - I'm totally for continuing the tax free nature of all income coming out of the TFSA, just don't let folks "double-dip" into the tax coffers.
This is not a problem at this time, and won't be for next several years.
However, after 10 years and beyond this will start becoming an issue for the then tax payers.

[kcowan]

This is not a problem at this time, and won't be for next several years.
However, after 10 years and beyond this will start becoming an issue for the then tax payers.I think the point is well-taken. I expect there will be enough other tax changes in the intervening 10 years to make the point moot. I agree with your principal.

(Of course the guy could plunk his whole TFSA into his principal residence if he is really rich and achieve the same thing. Granted that the income then comes from a non-deductible reverse mortgage.)

[Four Pillars]

Inspite of all my anti-tax ramblings, I'd be supportive of a move like that.
I don't think it's fair to let someone claim GIS when they may be earning hundreds of thousands from a TFSA account, say several years/decades from now.
That would be a good problem to have, IMO, and everyone should be that fortunate.

+1

[the-royal-mail]

There is really no limit to the number of fees and taxes the gov't can invent. But just because they CAN do it, doesn't mean that they should. In this case I find the concept offensive for the simple reason that the money has ALREADY BEEN TAXED. If I was lucky enough to be able to save $5k net in a year, after paying all that income tax, I shouldn't be additionally taxed on it later. That defeats the whole purpose of a TFSA.

As far as the growth, I was also told that I needed to invest the money I save in the TFSA, rather than keep it as a simple HISA. I have taken all the advice, there is no reason I should be taxed on the money A SECOND TIME.

[HaroldCrump]

I'm not suggesting that money in the TFSA be taxed, neither advocating withdrawals to be taxed.
Just treat it as normal income, but untaxed.
That'll ensure that it gets counted towards GIS & OAS eligibility.
Fair to the TFSA holder, fair to other tax payers.

[andrewf]

I agree with Harold, to an extent. It will take a long time to become a problem, but eventually, many people can use the TFSA to gain eligibility for government largess. Long term, OAS should be eliminated anyway, and GIS enhanced.

OAS is straight-up welfare for middle-class to upper middle-class retirees. It's not very equitable to be giving these folks money when we have people starving on the street and kids going to school hungry.

[HaroldCrump]

I'd be in thumping agreement for abolishing OAS and broadening the coverage of GIS.
That'll ensure the truly needy are taken care of, and ensure the current tax payers are not subsidizing wealthy seniors.
That makes the most logical and rational policy sense.
However, I recognize such a move would suck for the current generation of seniors and soon-to-be seniors, since they have already contributed to the tax coffers during the prime working years.
Given their numbers and political clout, I doubt any elected govt. will have the guts to even propose such a change.
I expect a more piece meal, unobtrusive claw back of the OAS by surreptitiously increasing the claw backs at each income tier and/or lowering the clawback ranges.

[Financial Cents]

My wife and I hope to have a tax problem in retirement, that means we don't have a money problem.

Years from now, when I'm ready to draw on OAS (23+ years), it might not be there. I too can see the gov't eliminating OAS many years down the road. That is probably their long-term strategy of introducing the TFSA, the gov't just isn't telling anyone (yet).

OAS is indeed, not very equitable. GIS on the other hand, that's the financial/social safety net for all.

[the-royal-mail]

You'll never win an argument with me on the basis that I should pay more due to the presense of poor people in the street. Let's recap:

-I got myself an education and worked my way through school to make something out of myself while other people were hanging out at the pub, dropping out of school and using student loan money to buy frivolous items.
-I have saved my money in a responsible manner through my life while other people were living it up and spending all their money having a great time on many trips and other consumer purchases.
-when I put $5000 into a TFSA, that is AFTER TAX, which means I had to earn much more than that just to clear that amount. this is what I deposited into my TFSA. *I* worked my butt off through my entire life to be able to make this deposit.

So the mention of fairness here is quite interesting to me, since it's anything but fair to penalize me and restrict access to the very gov't programs *I* paid for my entire life through high taxes.

[andrewf]

Hey TRM, I don't think you're alone in working hard, saving and paying lots of taxes here. Unfortunately for those of us with our sh*t together, it's our cross to bear to support those who don't and generally prevent them rotting in the gutter. Our main tool against that is to insist on more forced savings and the like. If we eliminate OAS, I'd support a significant mandatory increase in contributions to either CPP or a supplementary pension plan so that people who earn money will have to do some saving before they can blow it on a new car or a trip to Aruba. The answer is not to keep the current 'welfare for well-off old people' scheme we have now. And I'm saying that as someone who stands to lose from the elimination of OAS, eventually.

As far as how we eliminate OAS, I'd suggest a de-indexing of payments and the clawback threshold and let inflation take care of the rest.

[steve41]

Remember the ill-fated Seniors Benefit? That sure worked out.

Seniors are a formidable voting bloc.

[HaroldCrump]

You'll never win an argument with me on the basis that I should pay more due to the presense of poor people in the street. Let's recap:

-I got myself an education and worked my way through school to make something out of myself while other people were hanging out at the pub, dropping out of school and using student loan money to buy frivolous items.
-I have saved my money in a responsible manner through my life while other people were living it up and spending all their money having a great time on many trips and other consumer purchases.
-when I put $5000 into a TFSA, that is AFTER TAX, which means I had to earn much more than that just to clear that amount. this is what I deposited into my TFSA. *I* worked my butt off through my entire life to be able to make this deposit.I do not disagree with any of this...I'm totally on board.


So the mention of fairness here is quite interesting to me, since it's anything but fair to penalize me and restrict access to the very gov't programs *I* paid for my entire life through high taxes.But that's the thing...this will lead to lower taxes for everyone.
Since GIS and OAS are funded through general tax revenues (income taxes and other taxes), if we can avoid "poor millionaries" taking advantage of these two benefits, we can reduce income and other taxes for everyone.
Which means more money in our pockets for everything...save it, spend it, whatever.

[Karen]

Since GIS and OAS are funded through general tax revenues (income taxes and other taxes), if we can avoid "poor millionaries" taking advantage of these two benefits, we can reduce income and other taxes for everyone.
I don't understand why some of you are suggesting that "poor millionaires" are taking advantage of OAS and GIS. I understand that there are people who get around the rules, but I can't believe there are many millionaires who are willing to live with no comforts in order to be eligible for GIS.

My American husband died in late 2009, making me eligible for about $1200 (US) in Social Security payments. That income caused me to lose my seniors' credit in the 2010 tax year, and to lose about half of my OAS. That means that my SS pension, which my husband paid into all his working life, is netting me much less than it should. I'm not going to waste my time worrying about it, but I don't think it's right. I agree that we have an obligation to help support those who cannot support themselves, but I spent all my working life living frugally, and saving for retirement - my idea of a vacation most years was to take the ferry over to Victoria to visit my parents. I paid my taxes willingly every year on the understanding that when I reached 65 I would receive an OAS payment from the government. I'm not going to go hungry without it, but I would definitely be resentful if further limits to my government pensions were imposed.

[HaroldCrump]

I paid my taxes willingly every year on the understanding that when I reached 65 I would receive an OAS payment from the government. I'm not going to go hungry without it, but I would definitely be resentful if further limits to my government pensions were imposed.Karen, this discussion is getting off-track and mis interpreted.
No one is suggested reducing current seniors benefit, at least I didn't.
The discussion is about a future potential hypothetical (but likely) situation that can enable a rich retireee to take advantage of GIS by using a successful TFSA.
Such a scenario won't exist for at least a decade or two, if at all.

[the-royal-mail]

But that's the thing...this will lead to lower taxes for everyone.
Since GIS and OAS are funded through general tax revenues (income taxes and other taxes), if we can avoid "poor millionaries" taking advantage of these two benefits, we can reduce income and other taxes for everyone.
Which means more money in our pockets for everything...save it, spend it, whatever.

Harold, you know as well as I do that any small reduction like this will do nothing to actually lower our taxes. It will simply be gobbled up to satisfy yet more lobbyists who demand things like bike lanes and other such nonsense. The list just goes on and on. There are many competing interests for our money and I for one am not willing to pay one more cent in taxes. We both know the left loves nothing more to tax and spend and the last thing we should be doing is helping the gov't dream up more scenarios that will allow them access to our strained pockets. I feel NO shame in being rewarded for my lifelong hard work and frugality to save money for my own benefit. It's MY taxes that are funding these programs you want to take away from me. Making me pay more tax, whether you call it GST, HST, retirement clawbacks or whatever is not something I can afford. I've earned my money. Leave me alone. If others want the things I have, they can darn well work for it. Gov't programs are supposed to be there to benefit of all, not just for some minority/lobby/activist groups.

[andrewf]

In other words: I'm entitled to my entitlements!

[HaroldCrump]

Harold, you know as well as I do that any small reduction like this will do nothing to actually lower our taxes. It will simply be gobbled up to satisfy yet more lobbyists who demand things like bike lanes and other such nonsense. The list just goes on and on. There are many competing interests for our money and I for one am not willing to pay one more cent in taxes. We both know the left loves nothing more to tax and spend and the last thing we should be doing is helping the gov't dream up more scenarios that will allow them access to our strained pockets.Yes, that part is unfortunately true.
Govt. spending will always expand to use up all available finance, no matter how inefficient and irrational it may be.
The TFSA is the best thing that has happened in personal finance in the last 10 years (if not longer).
Followed by the 2% GST cut.

It will indeed be interesting to follow the developments around TFSA and see if any future govt. attempts to reduce its benefits to dip into the potential tax revenue.
In the meantime, grow it as much as we can.

[the-royal-mail]

Absolutely Harold. That TFSA is truly a marvelous thing. I wish I had a better handle on how well people are using this. Outside of this forum, I haven't heard a lot of people say they had set this up. I've started to hold investments in mine so I am excited to see it grow in the future beyond the 1.25% interest I've gotten. It will suck if they ever tamper with it. I just love the flexibility it offers in volatile times when I never feel safe locking anything away a la RRSP.

Also agree about the GST cut. That tax increase in 1991 where everyone tacked on PST and GST at the register really increased prices for all of us. I never saw evidence that prices were lowered by retailers or mfrs. So whenever I see people wanting to invent new fees/taxes I always remind them we're already paying extra by way of the GST and PST.

[Rico]

Also agree about the GST cut. That tax increase in 1991 where everyone tacked on PST and GST at the register really increased prices for all of us. I never saw evidence that prices were lowered by retailers or mfrs. So whenever I see people wanting to invent new fees/taxes I always remind them we're already paying extra by way of the GST and PST.

I remember I was in high school working at a fast food outlet and the day GST took effect our manager programmed the till to add 7% to the cost. No prices were changed, no adjustments were made.

[cannon_fodder]

I'm supportive of social programs, and I can understand why some would have an issue that the TFSA has the potential to create an ironic situation where GIS payments could go to someone who doesn't really need it.

On the other hand, I've had a long history of earning more than the average person and, as a result, paying more taxes than the average person. I've never felt that I get commensurately more benefit from paying those additional taxes.

It's unlikely I'd find myself in the hypothetical position where I was collecting a large, untaxable income from my TFSA and the GIS, but I certainly would not feel greedy for doing so.

[HaroldCrump]

I've never felt that I get commensurately more benefit from paying those additional taxes.Correct, a large % of taxes are "income transfer".
For the tax payers, that portion is not an investment that you can expect a return on after you turn 65 and retire.
It is merely an income transfer.
It's gone....whoosh....down the black hole.

[Larry6417]

Malcolm Hamilton actually predicted something similar 3 years ago. He predicted problems for gov't coffers a generation or 2 in the future if TFSAs supplant RRSPs; seniors would be living almost tax-free. He suggested that gov't taxation would need to switch from taxing income to taxing consumption i.e. sales tax.

Personally, I think GIS should be reserved for those in need. I'm not convinced that all seniors "need" OAS though. However, the optics of reducing seniors' benefits is awful. I wouldn't be surprised if gov't increased clawbacks quietly to reduce the cost of OAS without having an open debate about it.

http://network.nationalpost.com/np/blogs/wealthyboomer/archive/2008/03/05/tfsas-could-supplant-rrsps-and-spawn-future-generation-of-untaxed-pensioners-hamilton-says.aspx