Moving on TFSAs

As advisors consider how to strategically use the new Tax-Free Savings Accounts (TFSAs), one of the country’s largest insurance companies wants investors to consider insurance needs.

Sun Life Financial has announced it will offer TFSA solutions when the accounts become available on January 1, 2009. The plan is to offer the TFSA investment option to retail clients through accumulation annuities and GICs, and through its SunWise Elite suite of segregated funds. Employers with Sun Life Financial group plans can also choose to make TFSA options available to their employees.

Dean Connor, president of Sun Life Financial Canada, stresses that with fewer restrictions on what savings products can be used within the TFSA, Canadians should be working with advisors to assess what product usage within the TFSA would best suit their retirement goals – which may include insurance products.

“The TFSA is the most significant incentive for Canadians to save since the introduction of Registered Retirement Savings Plans,” Connor says. For example, Sun Life says a baby boomer could use a TFSA to directly fund future healthcare costs or to pay future premiums for coverage such as personal health insurance. A retiree could use it for an extended health care plan or for long-term care insurance.

“According to our research, a significant number of Canadians said that they worry about paying for healthcare costs in retirement, but the majority of individuals have not planned for it,” Connor says. “We know the increasing cost of health care is a concern for Canadians, and the TFSA can be a powerful incentive to help people plan.”

On the group side, Sun Life says the TFSA will allow employees to tax-effectively save to fund their future healthcare expenses and health insurance premiums using the company’s Extended Health Care Insurance. The policies can be purchased without proof of good health, if employees apply within 60 days of leaving their current health benefit plan.

On the flip side, the TFSA could also negate the usage of other insurance products, most notably Universal Life (UL) products, notes Preet Banerjee, a wealth advisor with Scotia McLeod.

Once the TFSA starts to build up contribution room – it’s limited to only $5,000 a year – it could overtake the leveraged deferred compensation strategy, which involves overfunding a UL policy and using it as collateral for an investment loan.

Banerjee says the strategy is commonly implemented by wealthier investors who max out their RRSP contribution room. The loan eventually gets paid off by the proceeds of the insurance policy, and usually there is money left over that has effectively grown tax-free.

“If someone has maxed out their RRSP and they are looking to reduce taxes, the only way they are going to get tax-sheltered growth over long periods of time until now is through the investment component of a UL policy,” he says. “You’re really supposed to prove a need for insurance with every policy, but a lot of people engage a UL policy as a way of creating wealth instead of insuring a need.”

Banerjee says with the TFSA you get everything the leverageddeferred compensation strategy offers, without having to purchase the insurance.

“The downside is that you only get $5,000 of contribution room initially. For a lot of those UL policies, you’re looking at people putting $50,000 or $100,000 and overfunding over time. It doesn’t give you as much contribution room, but if you keep on contributing on an annual basis, it’s going to be a viable alternative,” he says.

In fact, Banerjee says there is a reasonable argument to be made for keeping the TFSA strictly in equities for clients with a longer investment horizon, because it’s entirely tax-free.

“If you use both an RRSP and a TFSA, it might make sense to put the equities in your TFSA if they are expected to grow faster than fixed income investments over a long period of time and the withdrawal of funds will not be taxed,” he says.

Banerjee uses the example of an investor with a 30-year investment horizon, who is currently in the 40% tax bracket, and expects to be in the same bracket when they withdraw their money. If the investor put $1,000 into each of the RRSP and TFSA account – including reinvestment of the $400 RRSP refund – the TFSA would provide a superior return, because it would not be taxed when it is withdrawn.

If the $1,000 TFSA is invested in equities and grows at an average rate of 10% per year, after 30 years it will be worth $17,449.40. The $1,400 RRSP contribution would have grown to $24,429.16 at 10% over 30 years, but the taxes levied on the RRSP withdrawal would leave the investor with just $14,657.49. The TFSA nets the investor an additional $2,791.91.

“So long as you don’t violate your overall asset allocation, it makes sense to put as much of the equities into the TFSA as possible and as much of the fixed income in the RRSP as possible.”