8 assumptions that create bad retirement surprises for employees - #2

2. TFSAs are for savings 🤦

Here we have another misnomer. Employees may be fooled into thinking that TFSAs are only made for savings; that’s what the name says after all. Many assume savings means cash or a high-interest savings account. But in reality, you can pretty much put anything in a TFSA that you can put in an RRSP. They really should have been called Tax Free Investment Accounts.

To harness the power and maximize the tax savings feature of these accounts, your employees will benefit most when they hold their investments with the highest growth potential. 

Another point of confusion for many people is that interest income, like the earned on high-interest savings accounts, is also 100% taxable. So, one would think we should put the asset with the highest tax rate into a tax-free account. Again, there’s a lot more to it than that. Investments that earn dividend or capital gains income will be taxed at a lower rate per dollar earned. But with rare exceptions, the investments that can earn capital gains or dividend income tend to grow far more over the long term than even the highest interest savings account. For instance, if you only earn $300 of interest income from a high-interest savings account vs. $3,000 over the same period from investments that earn capital gains or dividend income, you’re going to save a lot more in taxes on the growth of the investments over the interest income. It’s not just the portion of the growth that’s taxable; it’s how much income there is to tax. 

Further, people often think there must be a tricky loophole, and that the withdrawals can’t actually be tax-free. But they really are! No matter how much lower one's tax bracket is in retirement, paying no tax is always going to be even better. 

The other thing that unfortunately influences the use, or lack thereof, for TFSAs is the fact that your employees won’t be motivated by a tax refund for deposits because they won’t be getting one. We can’t have our financial cake and eat it too. But the big benefit of these accounts is that a retiree can take withdrawals without paying any tax from their TFSA, and those funds also won’t drive up their tax bracket. With no effect on the tax bracket, or taxable income, TFSAs cannot cause retirees to keep less of their CPP, and their TFSA income does not reduce OAS in any way. 

TFSAs should also not be a default choice for employees saving for retirement. There should be absolutely no defaults when it comes to saving for retirement. But they should be considered as part of an overall retirement plan for most Canadians, especially those who will have at least some pension income, in addition to CPP and OAS. 

Did you miss assumption #1? You can read it here.