- What a TFSA is, and how it can help you save for retirement
- Why some people choose their TFSA as a retirement savings vehicle
- Whether the TFSA limits are high enough to be your sole retirement savings vehicle
Since it was first introduced in 2009, the Tax-Free Savings Account (TFSA) has gotten a lot of attention in the media. Some people see TFSAs as a short-term investment account, but others are drawn to it for long-term goals—especially as a tool for retirement savings. Prior to this, a Registered Retirement Savings Plan (RRSP) was the only tax-advantaged way to save for your retirement, but now the younger TFSA seems to be gaining in popularity.
The TFSA works very differently than an RRSP. Contributions to an RRSP are tax-deductible and the funds grow tax free. However, withdrawals from your RRSP are considered income, so you have to pay income tax accordingly.
By comparison, you don’t get a tax deduction for money you contribute to your TFSA, but still the funds are allowed to grow tax free. Also, when you want to make a withdrawal, your funds won’t be considered income. This difference has drawn the interest of some investors who want to lower their tax bills in retirement.
TFSA withdrawals will not impact your eligibility for government benefits like OAS.
This is why some Canadians are becoming excited about using their TFSA to fund their retirement. However, there is an important question...
Is your TFSA enough to retire on?
It’s easy to see why some people might like the TFSA, but is it enough to retire off of? Let’s do the math.
For the purposes of this hypothetical situation, let’s assume that you are earning a monthly OAS amount of $583.74 per month ($7,004.88 per year) and a monthly CPP amount of $643.92 per month ($7,727.04 per year). Let’s also assume that in retirement, you spend the Canadian average of $2,400 per month, and to keep the math simple for this example we’ll ignore inflation.
The life expectancy in Canada continues to slowly climb, with the average life expectancy currently in the 80s. If you retire at age 65, and enjoy 20 years of retirement you’ll spend $576,000 over your retirement. Over those 20 years, you will earn $294,638.40 from your Canada Pension Plan and Old Age Security Benefits. This leaves you with a difference of $281,361.60 that you need to make up from your savings. Can your TFSA cover that gap?
Looking under the hood at your TFSA
At first glance, the answer is no. In 2017, the cumulative maximum contribution room in your TFSA is $52,000. But the story doesn’t end there. The contribution room in your TFSA is increasing at a rate of $5,500 per year. And remember, investments made in your TFSA account are tax-sheltered, meaning that you pay no income tax on any investment returns your TFSA earns.
Some of us have healthy TFSA accounts already, but for many of us that isn’t the reality. Many Canadians haven’t even opened a TFSA or maxed out their available contribution room. So let’s look at the opposite end of that and examine the situation for someone who doesn’t yet have a TFSA.
Let’s assume that you opened your first TFSA this year and maxed it out with a $52,000 contribution. If the TFSA contribution room continues to grow at $5,500 per year, and your investments earn a reasonable rate of return of 6% (compounded annually), how long will it be until you reach the magic number of $281,361.60?
According to the calculators at GetSmarterAboutMoney it will take between 16 and 17 years.
What this means for you
Can you retire solely off your TFSA? Based on our examples, the answer depends on three things:
- Investment return
- How long you have to save money
- How much you'll spend in retirement
If you are one of those rare folks with a large TFSA portfolio, then congratulations! You might already be in position for the retirement you wanted. However, if you’re just starting to save for your retirement, earn a 6% return on your investments, and you plan on spending what the average Canadian does today in retirement… you might have a few years to go before you can retire the way that you want.
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This communication is intended for informational purposes only and is not, and should not be construed as, investment and/or tax advice to any individual. Trading in a TFSA may have tax implications. Please speak to a qualified tax advisor.