Jason Heath: A changed financial landscape means these four strategies might require a rethink
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Tax-free savings accounts have been a go-to savings vehicle for millions of Canadians in recent years. But some significant changes in the personal finance landscape mean that investors and savers may want to reconsider how they use their TFSAs in 2023. Here, I’ll explore the four main strategies that may require a rethink.
Interest rates have increased dramatically over the past year and those rate increases have influenced two of the four strategies. Savings account rates at banks were effectively zero in 2021 and early 2022 before the Bank of Canada started raising interest rates this past March. Whether that interest was taxable or tax free did not make much of a difference.
Now, a handful of institutions have introduced promotional offers at five per cent or higher and regular high interest savings account rates are in the three-to-3.5-per-cent range at many online banks. Interest rates are higher now than they have been at any time since the TFSA was introduced in 2009.
The tax payable on savings account interest can be more than 50 per cent depending on a saver’s income and province or territory of residence. Using a TFSA account to earn that interest may be worth considering.
Stocks on sale
That said, if someone has a choice to own stocks or have a savings account in their TFSA, there is a Boxing Day sale on now for long-term investors. 2022 has been the worst year for stocks since 2008, the year the TFSA was first proposed in the federal budget.
In 2022, the S&P 500 returned about minus 12 per cent for Canadian investors, the TSX returned around negative six per cent, and developed markets excluding North America generated losses of about 10 per cent. Stocks may or may not rise in 2023, but North American stock markets are trading at June 2021 prices right now. Investors with a long-term time horizon or who can dollar-cost average into stocks during 2023 are likely to reap the benefits five years from now.
Debt paydown more attractive
Mortgage interest rates were so low for so long that debt repayment lost its lustre. Now that big bank rates are in the six per cent range, borrowers with TFSA accounts should reconsider their saving and debt strategies.
A TFSA investor would need to earn a higher return on their TFSA than the interest rate on their debt to be better off not paying it down. An aggressive investor with low investment fees may come out ahead over the long run, but a conservative investor or an investor with unsecured debt may be hard-pressed to come out ahead financially. Unsecured lines of credit may be carrying interest rates well over 10 per cent and credit card rates could be 18 to 30 per cent.
If an investor has debt and can pay down that debt or contribute to their TFSA, this may be a year to reconsider whether taking a guaranteed return equal to their interest rate is better than investing in their TFSA. If an investor has a TFSA balance they are considering using to pay down debt and is hesitant to do it all at once, they could dollar-cost average out of their TFSA over time rather than in one fell swoop.
Homeowners with a low fixed interest rate mortgage that is coming up for renewal over the next few years may be able to earn a higher return on a savings account or GIC than their mortgage rate, so may be better off waiting to pay down their mortgage at renewal.
Competition from the FHSA
The tax-free first home savings account (FHSA) is being introduced in 2023 and accounts are expected to be available in April. The FHSA is similar to the TFSA given investments grow tax free and withdrawals can also be taken without tax payable, assuming the purchase of a qualifying home by a first-time homebuyer using an FHSA. The one advantage of an FHSA over a TFSA is that contributions are tax deductible. TFSA contributions are made with after-tax dollars with no up-front tax savings. So, up to $40,000 of contributions to an FHSA account can be claimed as deductions to reduce taxable income and generate tax refunds on a contributor’s tax return.
TFSA investors who anticipate buying a home in the next 15 years — the time limit for an FHSA account to stay open — may want to consider using TFSA savings to contribute to an FHSA.
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An interesting modification to Bill C-32 before it received royal assent on Dec. 15 was to allow an FHSA account to be used in addition to a home buyer’s plan (HBP) withdrawal from a registered retirement savings plan (RRSP). This was not the original intent when the FHSA was proposed in the last federal budget.
The change means a first-time homebuyer can withdraw up to $35,000 from an RRSP under the HBP and can also contribute up to $40,000 to an FHSA, with an unlimited FHSA withdrawal. So, aspiring homebuyers whose RRSP balances are approaching $35,000 may want to consider shifting their attention to the FHSA, perhaps at the expense of TFSA contributions.
Financial planning for the masses as well as individuals needs to be reconsidered over time. A financial plan should not be stagnant. The answer to whether you should change your TFSA planning depends on your personal circumstances but is due for revisiting.
Jason Heath is a fee-only, advice-only certified financial planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever. He can be reached at [email protected].