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Defend savings from a surprise tax grab

Thursday, February 9, 2012

The government has a growing appetite for new sources of revenue. Hedge your bets: Use both RRSPs and TFSAs

ROB CARRICK

rcarrick@globeandmail.com

RRSPs or TFSAs for your retirement savings? Let the debate over the future of Old Age Security be your guide to the right choice.

There's talk that Ottawa will, over time, raise the age at which people can claim OAS to 67 from 65. With seniors expected to account for one-quarter of the population within 20 years, the government is looking for ways to contain spending growth in programs such as health care and OAS.

Now let's jump ahead a decade or so and imagine that efforts to keep spending in hand have not worked out. Hungry for revenue, the government looks for ways to cut spending and raise taxes. As part of an effort to ensure all segments of the population share the pain, registered retirement savings plans and tax-free savings accounts come under review.

The usual point of comparison between TFSAs and RRSPs is the amount of tax you pay on the money you contribute today, and on the money you'll withdraw in the future. Now, there's something else to think about. Which savings vehicle is easier for the government to raid for extra revenue?

RRSPs get the nod here for sure, but TFSAs could get whacked, too, if the government needed every possible cent of tax revenue. That's why today's smart savers will hedge their retirement savings by using both.

At a time of perpetual angst about inadequate retirement savings, it may seem far-fetched to talk about the government changing RRSPs and TFSAs for the worse. In fact, the government is trying to strengthen the retirement savings system right now by introducing the pooled registered pension plan, or PRPP, which is a mechanism for helping small employers provide a pension-like savings plan for workers. It's supposed to help the many workers who aren't now covered by an employer pension plan.

The possibility that the OAS will pay out less is another reason to expect the government to leave RRSP and TFSAs alone, and even maybe enhance them. If the government delays your OAS by two years, it's up to you to save more to cover that period. The government can't very well take away with both hands.

And yet, one of the biggest financial lessons of the past several years is that preparing for the worst is not a wasted effort. Canada's economy is in good shape on a comparative basis globally, but a long period of weak growth coupled with the demands of an aging population could put major stress on federal government finances. In turn, the government could adopt a variety of measures that affect all parts of the population, including retirees and people saving for retirement.

What might the government do? Jamie Golombek, managing director of tax and estate planning at CIBC Private Wealth Management, speculated that the maximum annual contribution to an RRSP could be rolled back. For the 2012 tax year, the contribution ceiling is $22,970.

RRSPs must be converted to registered retirement income funds by the end of the year in which you turn 71. RRIF rules as they are now bug a lot of seniors, but Mr. Golombek said they could certainly be stiffened by a government looking to boost tax revenue. For example, mandatory annual withdrawal amounts could be increased, thereby prying more taxable income out of registered plans.

Measures like these wouldn't solve a cash-hungry government's problems, which is why the risk of an income tax increase at some future point can't be dismissed. Users of RRSPs and RRIFs would be prime victims of a higher tax rates, while TFSA holders would be immune.

RRSPs are all about tax deferral. Make a contribution and you get the tax back on that amount. Then, when you withdraw money from a RRIF to live on in retirement, you pay tax on that. Contributions to TFSAs are made with money on which you're already paid your taxes.

"With TFSAs, you've paid your tax up front, and you'll never pay tax again," Mr. Golombek said. "What's done is done."

TFSAs look to be safer from government tampering than RRSPs and RRIFs, but they're not invulnerable. Mr. Golombek said a desperate government could curtail the tax-free status of TFSAs and start applying income tax on investment gains in these accounts as of a certain date. "That's if they wanted to eliminate the TFSA, which seems ridiculous given all the effort that's gone into it and how Canadians have adopted it."

If the government makes changes to the OAS now, what's to say it won't raise taxes or make other changes if conditions worsen in the years ahead? Insure your retirement savings by using TFSAs as well as RRSPs.

For more personal finance coverage, follow me on Twitter (rcarrick) and Facebook (Rob Carrick).

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TFSA/RRSP CHEAT SHEET

TFSARRSP
Annual contribution limit for 2012$5,000$22,970
Tax deduction for contributions?NoYes
Tax sheltered gains inside the plan?YesYes
Tax payable on withdrawals?NoYes
Who can use them?People 18and upPeople with earned income
Maximum ageNoneAt the end of the year you turn 71, must be convertedinto a RRIF/annuity, or cashed in