Monogamy in investing? There is no monogamy in investing, and for all the ethical investors in the room, when it comes to the “Tax Man”, you have no sympathy
 
It is submitted that for the most part we have all been relatively disciplined with RRSP contributions. In fact, some may argue conditioned; but with all the investment vehicles available the question becomes  “are RRSPs still the “King of the Hill”? A difficulty among advisors is convincing a client to forgive the “upfront” tax benefits of an RRSP and consider the TSFA.  For the majority, the most optimal option will still be RRSP’s. However, in some unique scenarios TSFA is a better solution and we will consider two possible scenarios.
 
First, consider the propaganda released by the Department of Finance comparing TSFA’s and RRSP’s.
 

  
To understand the “forgone consumption”, we will rationalize how much we keep from our earnings. If an individual is within a 40% marginal tax rate and earns $1000.00 gross they will be taxed $400.00, receiving a net pay of $600.00. Subsequently, when we invest $1000.00 in RRSP’s, we benefit from a $400.00 tax refund.  Therefore, in this example, the $1000.00 is based on gross dollars earned. Using the same logic, when we invest into a TSFA or an open investment the amount invested is post tax dollars.  Therefore, we earned $1000.00 gross but our investments only benefit by the net proceeds of $600.00 as we lost $400.00 in taxes.

Based on this illustration both RRSP’s and TSFA’s provide the same equal benefit. The challenge is that an RRSP is commonly referred to as a “tax deferred” vehicle which effectively defers taxation to a later date; a time referred to as “retirement” when the marginal tax rate would be lower. The defect with the illustration is that the marginal tax rate should be lower during the retirement years. 

Consider a true illustration for TSFA vs. RRSP when the marginal tax rate is lower during retirement.
 

In the second scenario the RRSP is clearly the better choice. It produces an average annual compound rate of return of 6.3 percent over 20 years compared to 5.5 percent from a TSFA. What this means is that higher-income people who anticipate that their tax rate will be lower after retirement should top up their RRSP’s first, before investing in a TSFA. This would encompass the majority of my clients.

Let us consider two scenarios where the TSFA will benefit investors directly.

1. Pension Plan Members

  
Anyone who belongs to a pension plan loses RRSP contribution room because of the “pension adjustment” (PA). Calculating these pension adjustments can be complex because you must take into consideration both the employer and employee contribution. If you are one of the remaining few who still benefits from a generous plan your pension adjustment will be higher. TSFA’s now provide a secondary vehicle for those who find themselves short of contribution room at the end of the year.

2. I love being a single father… and so does my accountant!!!!

Yesterday, my son and I ate out at a local East Side Mario’s where he introduced me as his brother – cute.  The bartender thought so as well - that’s for another blog. Outside of all the real reasons for my ecstasy as a parent, there are also the tax benefits forwarded by the Government. My marginal tax is substantially lower from a potential 40% to as low as 25%, but it won’t last forever. As I’ve previously experienced take advantage of the peaks to prepare for the valleys, and in this case, the taxation valleys. Eventually, my son will no longer be considered a dependant and, outside of adopting a child, my marginal tax will increase by close to 50% - oh my!
 
Here is the primary problem; RRSPs were designed to defer taxation until retirement. In theory, our marginal tax should be lower during our retirement years minimizing the penalties when we draw funds through an RIF to support our standard of living. It is quite possible that my marginal tax will be higher during my retirement years in comparison to my “single father golden years”.
 
Consider the chart below:
 
 

 
TSFA presents an opportunity for me to hold my “potential RRSP funds” to a point in the future where my marginal tax rate will increase. Ideally, I will have an opportunity to transfer tax shelter earnings to my RRSP’s benefiting from a larger contribution that only includes the principle but also tax free compounded earnings.

The TSFA now fills the gap for those modest income earnings with a tax efficient vehicle. Don’t be overlooking the consequences of tomorrow for the benefits of today.

While financial blogs and commentaries will provide insight into these products a tailored plan through a Financial Planner is the best approach.