Retirement is idealized in advertisements as a time of comfort and leisure.

That’s because it’s when the physical and psychological stresses of work life are laid aside, and replaced by an enriched personal life underpinned by financial security.

You’ve all seen the pictures of fit, smiling senior couples strolling along beaches and gazing at sunsets. I can’t speculate on personal enrichment (since it’s something very much in the eye of the beholder), but I do know that the financial aspect of retirement cannot be taken for granted.

Like any other stage of life, retirement has key financial risks. In 2011, Fidelity Investments Canada published a report entitled “After the Global Financial Crisis: The Five Key Risks to Retirement Income.” Thanks to that report, we know investors should be aware of:

  • longevity;
  • inflation;
  • asset allocation;
  • withdrawal rates; and
  • health care costs.

Though retirement-age clients have to manage these risks under any circumstances, the reports says the financial crisis and recession of 2008-2009 filled investors with uncertainty for the future and the halting economic recovery we’ve seen since continues to undermine confidence.

As an advisor, there’s much you can do to rebuild confidence. You can start by helping clients develop written retirement plans.

In this article, however, I want to talk about how TFSAs can be used to mitigate the five key risks of retirement. Although individuals are limited to annual TFSA contributions of $5,500, these accounts have some clear advantages when it comes to building longer-term income security.

Living long, and prospering

The evidence is clear that many people need more retirement savings. In 2011, the median retirement age in Canada was 63.2 for men and 61.4 for women, said StatsCan data, compared to 61.3 and 59.9, in 1997. Now, people expect to be retired around age 66.

That’s because they need more funds, especially given the fact life expectancies are increasing. Someone retiring today could well spend as much time at leisure as he or she did at work.

But the prospect of living 30 or more years after retirement increases the risk that individuals will outlive their savings, so potential longevity must be factored into retirement planning.

The role TFSAs can play in this respect becomes evident when you compare them to the principal savings alternatives, non-registered accounts and RRSPs.

Let’s start by comparing a TFSA with a non-registered savings account. Contributions to both are made with after-tax dollars, and both accounts offer similar scope for diverse investments. But while the TFSA will generate tax-free earnings on investments, the non-registered account’s returns will be taxed. Clearly then, reinvested TFSA earnings will be greater than the after-tax non-registered account earnings. And given the impact of compounding over the years, TFSAs will eventually produce higher account balances for your clients.

Your clients can also benefit from the TFSA’s capital gain advantage. When investment assets in non-registered accounts are sold, they can easily trigger capital gains. Half of the capital gain from any sale will then be included in an individual’s taxable income. Capital gains from TFSAs are not included in taxable income, nor do withdrawals from TFSAs incur any tax. From a tax perspective and longer term values then, TFSAs have clear advantages over non-registered accounts.

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“An RRSP will be the better choice if your client’s current tax rate is higher than the expected tax rate in retirement”

This is certainly no more than a general rule. The flexible timing of withdrawals (or none)from TFSA compared to compulsory withdrawals from registered funds may be more important than relative tax rates.

Wednesday, Jul 6, 2011 at 2:17 pm Reply

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