It’s been a little more than a decade since the former federal Conservative government introduced the tax-free savings account (TFSA) as a financial planning tool to help Canadians increase their net worth. However, recent research shows the TFSA has been used more as a piggy bank than a tax-efficient investment vehicle – and financial advisors believe this is a missed opportunity for investors.
A recent Royal Bank of Canada (RBC) survey reveals that 43 per cent of Canadians believe TFSAs are for savings and not for growing investments, although about two-thirds (65 per cent) of TFSA holders said they haven’t withdrawn money from these accounts.
The survey also shows the top five holdings in a TFSA are cash, at 42 per cent, followed by mutual funds (28 per cent), stocks (19 per cent), guaranteed investment certificates or term deposits (15 per cent) and exchange-traded funds (ETFs; 7 per cent).
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Many advisors blame the misleading word “savings” in the TFSA and believe it’s up to them and the investment industry to outline the benefits of tax-free returns to help investors reach their financial goals.
“It’s probably the worst-named product in the investment world. They should’ve called it a tax-free investment account or something along those lines,” says Stuart Gray, director of RBC’s Financial Planning Centre of Expertise.
(A Department of Finance Canada spokesperson would only say that the “government of the day made the decision” when asked why the vehicle was named the TFSA.)
Although some Canadians are drawn to the flexibility of having cash in their TFSAs, Mr. Gray says they’re missing out on the advantage of using the account to invest in a variety of products and to benefit from compounding, tax-free returns.
“Advisors have a role in helping clients understand the benefits of a TFSA and how they align to their broader goals,” he says. “It really comes down to the flexibility of the TFSA.”
Mr. Gray uses the example of new parents who can use their TFSAs, alongside a registered education savings plan, to help put a child through university in the future. TFSAs can also be used alongside a registered retirement savings account (RRSP) to help fund a retirement decades down the road.
“Advisors have an opportunity to engage and educate clients around the benefits of [using both] an RRSP and a TFSA,” he adds.
A big reason for Canadians’ misunderstanding about the TFSA is that, for years, financial services institutions have encouraged investors to open TFSAs, often without explaining the various benefits, says Rona Birenbaum, certified financial planner and founder of Toronto-based fee-only financial planning firm Caring for Clients.
Although those conversations are evolving as the TFSA itself becomes a more mature savings and investing vehicle, Ms. Birenbaum says advisors need to motivate investors to use the funds more strategically.
For example, she says one strategy might be to establish separate accounts within a TFSA based on financial goals. (According to the Canada Revenue Agency, investors can hold more than one TFSA so long as the total amount contributed is not more than their available contribution limit.)
“A short-term emergency fund is fine in a high-interest vehicle, while longer-term goals should be more growth-oriented and include equities and fixed-income [securities] or ETFs,” Ms. Birenbaum notes.
Advisors should also use examples to show investors the difference even a slightly higher return can make with tax-free compounding, including how much would be saved in taxes.
“It’s not enough to just say you’ll be better off,” she says. “The best and most effective way to motivate investors to approach their TFSA with more of a growth-oriented mindset is by illustrating the difference in their financial trajectory. Because of the tax-sheltered nature of the TFSA over a reasonable time frame, the difference becomes extremely compelling.”
Adds Ms. Birenbaum: “In our experience, with very few exceptions, that has done the trick.”
Sylvain Brisebois, senior investment advisor and portfolio manager at BMO Nesbitt Burns Inc. in Ottawa, says the TFSA has been marketed broadly as a quick and accessible account when the focus should really be on the “tax-free” element instead.
“Any time you can talk about a tax-free anything in Canada, there’s a benefit there somewhere,” Mr. Brisebois says. “The more you grow [your assets] inside of a TFSA, the more a TFSA is worthwhile. … If you do good, proper financial planning, the TFSA is probably one of the last places you would tap into to get money.”
Mr. Brisebois encourages advisors to check-in regularly with clients – alongside the broader portfolio review – to ensure the TFSA is being used its full potential, based on their financial goals.
“Everyone knows a TFSA is a good thing, but when you start explaining why that is, it becomes easier for investors to make sense of it,” he says. “If we, as advisors, see that they’re using the TFSA to hold cash or as a reserve, let’s call them out. Let’s not let them make that mistake.”