In the week since the Federal Budget was tabled I have read numerous articles discussing the changes to TFSA contributions and RRIF withdrawals. One of the more common topics was whether or not this budget benefited the middle class or was it strictly for the wealthy.
I have attended a few industry webinars in addition to reviewing a significant portion of the 518 page budget document, all in a quest of forming a personal understanding of how this budget, specifically the changes to TFSA and RRIF, could help Canadians in general.
I also discovered that I was not alone in my desire to understand. The day after the budget was tabled an advisor contacted our software support line to ask when we would be implementing the RRIF and TFSA changes within The Razor. Since then we have received numerous phone calls and emails asking that same question. Like me, advisors all across Canada want to understand firsthand how this budget impacts their clients’ financial plans.
So I decided to do a before and after comparison of the financial plans for two hypothetical clients, a 55 year old middle-class married couple and a 55 year old high-income married couple. Both clients are identical in all aspects except family income, wealth accumulation, and lifestyle goals at retirement.
The analysis assumed retirement at age 65, RRIF at age 71, inflation of 2%, investment returns of 5%, and a withdrawal order of:
- RRIF (minimum withdrawal)
- Non-registered (interest and principle)
- TFSA (interest and principle)
- RRIF (additional withdrawals required to meet needs)
The financial assumptions were based in part on values provided by Statistics Canada and my own experience as a financial planner:
For both couples the analysis assumed maximum RRSP contributions to age 65 with a current RRSP balance equal to 10 times the annual contribution amount respectively.
In addition to RRSP contributions, the middle class couple each contributed 50% of the current pre-budget maximum to TFSA. The high income couple each contributed 100% of the current pre-budget maximum to TFSA with an equal amount deposited to non-registered investments earning taxable interest.
Both couples retire at age 65 and immediately begin drawing down assets to supplement CPP and OAS up to their desired after-tax retirement income goal (OAS does not begin until age 67). This approach provided an easy way to measure the impact of the new rules by simply recording each couple’s assets at life expectancy as any tax savings over the years would be reflected in this amount.
In the case of our middle class couple, they had projected assets at age 90 of $342,000 consisting of $282,000 in RRIF and $61,000 in TFSA. In contrast, our high income couple had projected assets of $746,000 consisting of $719,000 in RRIF and $28,000 in TFSA.
After implementing the changes to TFSA contributions and RRIF minimum withdrawals, our middle class couple had an overall increase in assets at age 90 of slightly less than $21,000 or 6%, while our high income couple had a marginally better increase of $88,000 or 12%.
In both cases, the reduced RRIF factors in the budget resulted in larger withdrawals from TFSA starting at age 71 and the complete liquidation of all TFSA savings by age 90.
When you consider just how small the impact was, the recent changes would appear to offer little long-term financial benefit to either couple. But I didn’t stop there.
Impact of an Inheritance
Recent studies suggest that in the years to come nearly a trillion dollars will pass from one generation to the next in the form of an inheritance. This fact would suggest that any analysis should also incorporate a future lump-sum for both couples.
I decided to use age 65 as the year each couple would receive an inheritance and that I would run three scenarios of $250,000, $500,000 and $1,000,000 as the amount inherited. I assumed each couple would immediately top-up any unused TFSA amounts with any remaining balance deposited to non-registered.
Both couples would also max out TFSA contributions each year in retirement using any excess income and non-registered investments if any existed.
The Middle Class Inheritance Analysis
In the pre-budget inheritance analysis our middle class couple saw their RRIF grow 14% to $321,000 at life expectancy for all scenarios, indicating that an additional $250,000 was enough to eliminate the need for any RRSP withdrawals over the minimum required. This was also the case for the post-budget analysis with the RRIF growing by 30% to $474,000 in all scenarios, the larger amount is due to the reduced withdrawal factors and the availability of additional TFSA to draw from.
In the post-budget analysis the larger TFSA contribution limit was of most value when our middle class couple inherited $1,000,000, increasing the TFSA asset by more than 31% to $481,000 at age 90.
However, what was of most interest to me was that even though our middle class couple were able to take full advantage of the higher TFSA contributions, the overall financial impact was nominal at best. Less than 7% increase in overall assets at age 90 in all scenarios!
The High Income Inheritance Analysis
In the pre-budget inheritance analysis our high income couple had next to no increase in the value of their RRIF at life expectancy in all scenarios, confirming the additional capital from the inheritance was not needed for income. In the post-budget analysis however, the RRIF grew by 31% to $1,095,000 in all scenarios, suggesting the additional capital from the inheritance allowed the couple to take full advantage of the lower RRIF withdrawal factors to preserve more of their RRIF value.
In the post-budget analysis the larger TFSA contribution limit was again of most value when the couple inherited $1,000,000, increasing the TFSA asset by 32% to $2,306,000 at age 90.
Again it surprised me that with the ability to take full advantage of the higher TFSA contributions and the lower RRIF withdrawal factors, the overall financial impact was less than 12% improvement at age 90, over all scenarios.
To put this into perspective, a mere increase of 0.25% in investment return assumption had a greater impact on assets at age 90 than did the latest budget changes!
With all the hype surrounding the new TFSA limits and the lowering of the RRIF withdrawal factors, I would have thought there would be more of a financial benefit to average Canadians. I certainly did not expect it to amount to an additional 0.25% return on investment.
Based on my analysis, the individuals that will benefit most from this budget are the same ones that have benefited the most from every budget in the past… the planners!
Every Canadian can benefit from lower RRIF minimums and higher TFSA contributions, but only if they are willing to create a plan and follow it. Individuals that choose to do nothing will see very little financial benefit from these changes.
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