Although it may be too early to make a prediction, initial member behaviour shows responsible use of the product. Withdrawals to date have been negligible, indicating that members are taking advantage of the flexibility of group TFSAs for mid- to long-term savings. The early adopters may have been more confident about opening their accounts because they didn’t experience the financial stress that some Canadians did last year.
Benefits and drawbacks
TFSAs can benefit plan members in a number of ways.
• Capital gains and interest earned in a TFSA are excluded from taxable income during the accumulation years and in retirement.
• A TFSA doesn’t need to be converted to another product when the member reaches age 71.
• Amounts withdrawn add to the following year’s contribution room.
• Contributions to a spouse’s account don’t attribute income back to the spouse who gifted the funds or reduce the gifting spouse’s contribution room.
However, some features of a group TFSA may not suit your plan or your plan members. For example, there are relatively low annual contribution limits (currently, $5,000 a year) compared with an RRSP. For Canadians in the highest tax brackets, the contribution limit is a low percentage of income. Plan sponsors can’t limit withdrawals because federal rules prohibit withdrawal restrictions by third-party administrators. And some additional member education is advisable, since plan members should learn how to use the TFSA to their advantage.
Finding a fit for TFSAs
TFSAs are best suited to the following situations.
High-income earners – The TFSA can supplement retirement savings for employees who have maxed out their RRSP and registered pension plan (RPP) limits. If this description fits your plan membership, keep group TFSA investment options similar to those in the group RRSP and/or RPP. Similar plan offerings will simplify communication, plan administration and member investment choices. If permitted by the plan sponsor, the plan member’s spouse can also hold a group TFSA, which allows for spousal gifting without the effects of the income attribution rules—another attractive feature for high-income earners.
Low- and middle-income earners – Timing contributions can help these members, who may choose to put savings aside in a TFSA until they reach a higher tax bracket. At that time, these members can transition their group TFSA savings into the group RRSP for maximum tax-reduction benefit. Having access to both products with the same investment options in a group plan allows the member to make a seamless transfer without getting out of the market or making another investment choice.
First-time homebuyers – RRSP withdrawals through the Home Buyers’ Plan require scheduled annual repayments that don’t reduce taxable income. A missed repayment will be included in the member’s taxable income. By opting to save for a home with a TFSA, the member has greater flexibility to make withdrawals and any repayments.
Healthcare spending – According to recent Statistics Canada data, the average 65-year-old male lives to age 83, while the average 65-year-old female lives to almost age 86. As longevity increases, the need for healthcare after employees leave the workforce becomes even more important. Savings in a group TFSA could be earmarked by the member to purchase future healthcare coverage.
Estate planning – Amounts accumulated in a TFSA pass tax-free and probate-free to beneficiaries. Also, the account can be kept intact by a surviving spouse. RRSPs allow a rollover to a spouse or dependent child, but the funds will be paid in full to other named beneficiaries without withholding tax, leaving the estate potentially short of cash to cover the related tax liability.
Critical illness funding – Withdrawing from an RRSP to cover the costs of an unforeseen illness can have a devastating effect on retirement funding—especially for those in higher income brackets, who value their limited RRSP room. In contrast, TFSAs allow withdrawals at any time, for any purpose, without withholding tax.
Provinces with lower tax rates – Marginal tax rates depend on where the employee works. The amount of marginal tax for two employees earning the same income but located in different provinces can change the benefit of investing in a group RRSP as compared with a group TFSA. Employees living in a province with lower marginal taxes, such as Alberta, could be better off investing in a TFSA because contributions are made with comparatively higher after-tax dollars.
