SPP or TFSA?

By Sheryl Smolkin

You have $2,500 to contribute to retirement savings in 2012. Should you contribute to a tax-free savings account or the Saskatchewan Pension Plan?

Before answering that question, it is helpful to review some basic SPP and TFSA concepts.

SPP
You can contribute a maximum of $2,500/year to SPP providing you have RRSP contribution room. To find out how much RRSP room you have available in 2012, look at line A of the RRSP Deduction Limit Statement on your 2011 income tax notice of assessment or notice of reassessment.

Your SPP contributions are tax deductible and investment income accumulates tax sheltered. SPP contributions plus interest are also locked in. Unused contribution room is carried forward.

You may elect at anytime between age 55 and 71 to receive an SPP pension or move your SPP account balance into a locked-in RRSP. By age 71, amounts in a locked-in RRSP must be converted to income using a prescribed registered retirement income fund (pRRIF) or life annuity product. You must begin making minimum prescribed withdrawals from your pRRIF in the following year.

Both SPP annuity payments and pRRIF withdrawals are fully taxable income at your marginal tax rate. If your SPP benefits or pRRIF withdrawals push your income over specified limits, a portion of Guaranteed Income Supplement, the age credit and Old Age Security payments may be clawed back.

TFSA
You can contribute up to $5,000/year to a TFSA regardless of your age or income level. Contributions are not tax-deductible. However investment income  (including capital gains), accumulates tax free. When funds are withdrawn from a TFSA, no income tax is payable.

You can withdraw funds available in your TFSA at any time for any purpose — and the full amount of withdrawals can be put back into your TFSA in future years. Re-contributing in the same year may result in an over-contribution amount which will be subject to a penalty tax.

Neither income earned in a TFSA nor withdrawals affect your eligibility for federal income-tested benefits and credits. You can provide funds to your spouse or common-law partner to invest in their TFSA.

By the numbers
All other things being equal, whether or not you will be able to save more in the SPP or a TFSA depends on two key factors.

  1. Your marginal tax rate when contributing as compared to your marginal tax rates when you expect to withdraw the money.
  2. How you use your tax refund.

Generally speaking, if you think your marginal tax rate will be significantly lower at retirement than during your working career, saving with SPP makes much more sense than in a TFSA.

But how you use your tax refund is also important. Canada Revenue Agency calculations when the TFSA was introduced assume the tax refund generated by contributing to a retirement savings vehicle is also contributed to the account.

In these circumstances, investing in either the SPP or a TFSA will result in about the same net withdrawals at retirement. However, many of us look on our tax refund as “mad money” and do not earmark it for further retirement savings. In these situations, the TFSA comes out ahead.

That money can be withdrawn from your TFSA account and contribution room is restored in the next year may be attractive in some cases. However, replacing money you withdrew requires considerable discipline. In contrast, money saved in your locked-in SPP account will be there at retirement when you need it.

Your financial plan
SPP vs TFSA. It’s not an either/or proposition. A financial advisor can review your personal situation and help you decide the best way to maximize your retirement savings.

Depending on your income level, expenses and the amount of income you need in order to retire, you can benefit from having both kinds of accounts plus an RRSP.

To paraphrase David Chilton in TheWealthy Barber Returns:

  1. If you go the SPP* route, don’t spend your refund.
  2. If you go the TFSA route, don’t spend your TFSA.
  3. Whatever route you go, save more.

* Chilton used RRSP in this phrase.

Also read:
Understanding SPP annuities

The Wealthy Barber explains: TFSA or RRSP?

RRSP vs. TFSA: Tim Cestnick on where to put spare dollars

To TFSA or to RRSP?

TFSA vs RRSP – Clawbacks & income tax on seniors

TFSA vs. RRSP – Best Retirement Vehicle?

September 2012 returns

SPP posted a return of 2.01% to the balanced fund (BF) and 0.05% to the short-term fund (STF). The year to date return in the BF is 6.14% and in the STF is 0.36%.

Market index returns for September 2012 were:

Index Sep 2012 return (%)
S&P/TSX Composite (Canadian equities) 3.43
S&P 500 (C$) (US equities) 2.90
MSCI EAFE (C$)
(Non-north American equities)
2.66
DEX Universe Bond (Canadian bonds) 0.67
DEX 91 day T-bill 0.10

Talking to David Chilton

David Chilton podcast

Hi, my name is Sheryl Smolkin. I’m a lawyer and a journalist. Today I’m pleased to be continuing the Saskatchewan Pension Plan’s new series of financial expert interviews with the Wealthy Barber himself…David Chilton.

The Wealthy Barber has sold more than 2 million copies in Canada, and last year — some 20 years later — The Wealthy Barber Returns was published.

I recently heard David speak at the Human Resources Professionals Association conference in Toronto and was delighted when he agreed to do an interview for the Saskatchewan Pension Plan Financial Expert podcast series.

Welcome David.

Q1. In your first book The Wealthy Barber, the well-to-do barber Ray Miller’s first and most important rule is take 10 per cent off every pay cheque as it comes in and invest it in safe interest-bearing instruments. Why do you think so many people have so much difficulty overcoming their inertia and taking that first important step?

A.1 It isn’t necessary to invest only in interest-bearing certificates. If you are a long-term investor building for retirement, Miller was fine with allocating some of the money towards growth-oriented vehicles like equities or mutual funds that have equities in them, but the basic thrust of saving 10% of every pay cheque is absolutely the key.

The problem today is that we love to spend, and so we resist any savings technique that limits our ability to go out and buy things. Also, society has taken on so much debt that it has squeezed our ability to save. It’s tough for people to set aside 10% of their net or gross income because they’re servicing debt now. We love to spend we love to keep up with the Jones’s, but to some extent, we’re sacrificing our future.

Q2. You acknowledge that it’s only human for the desires of Canadians to run well beyond our stream of “needs” into our pool of “wants,” but still maintain that many people have too much stuff. Do you think people should be making sacrifices today in order save for the future?

A.2 I do. And I hate the word “sacrifice.” It has such a negative connotation. I would argue after seeing thousands of people and their personal finances, that people who are saving successfully are happier, because they’re less stressed about their financial future. They are not caught up in that race to consume as much as they can.

Remember, nobody is suggesting massive cuts to your spending and an austerity budget. Let’s be realistic here, let’s set aside at least 10%, hopefully more. It’s doable. It doesn’t require major cutbacks – just spending a little less here and there to force savings.

Q3. How can people resist the temptation to buy more clothes, or jewellery or electronics – whatever discretionary spending is distracting them from saving for the future?

A3. It’s interesting. People who read my book say even reading about the psychology of spending has helped them have a little bit of a mind shift. But there are some safeguards that you can put in place. The problem in the last 20 years has been the ubiquitous availability of credit. It’s so easy to mindlessly swipe your credit card or write a cheque against your line of credit. If you want human nature to have less ability to sabotage you, take it out of the equation.

So you are seeing more people staying away from lines of credit now and I notice a lot of people going back to a cash-based spending system. They are taking out cash on a Monday and saying, my budget is $450. That money is in their wallet for everything from groceries to gas. When the money runs out, so does the spending. I love that approach because when the money leaves your wallet you feel a little pain and realize it is a finite resource.

When you are swiping debit or credit cards mindlessly, it’s too easy to spend and hard to keep track of. Spending quickly increases to an unacceptable level.

Q4. Tell me about the four liberating words of advice you give to people who come to you for help because they are overspending. Do they really work?

A.4 That is the chapter I hear the most about in the book and it’s a very simple concept. People really expect deep advice from me, but what I say is you’ve got to start saying to yourself and to others, “I can’t afford it.”

It’s hard at first, but when you start saying it then you realize, it’s not admission of failure it’s just accepting the reality. In fact it’s stress reducing because you are accepting the reality, you’re no longer stretching beyond your needs.

I cannot believe all the letters and phone calls I’ve had from people across the country who say they love the chapter. They’ve become used to it, they are embracing it and they are actually enjoying it.

Q5. Home renovation is a bottomless money pit that many people get sucked into in the hope of improving their property value or keeping up with the Joneses next door. When it comes to renovating or anything else, what are the four most expensive words in the English language?

A.5 Since the book has come out, I’ve come to think that I understated the case of excessive home renovation. We’ve received so many emails and letters from people saying if you think your examples are bad, look at mine.

I am not against home renovations. I renovated my own home a few years ago. The problem with home renovation is you do one room like your kitchen or your basement and the rest pale in comparison. And all of a sudden the cycle of renovation rolls on. With lines of credit making cash available, it’s very difficult to resist the temptation. I think of all the people I see who have line of credit problems, about 50% got that way through excessive home renovations.

Q6. The cost of housing has gone up tremendously over the years in Canada. Can homeowners depend on the value in their homes as a source of income in their retirement?

A.6 Well, not really. Seniors don’t necessarily want to sell their home in retirement. They like the neighbourhood. Many don’t move because they want to have the extra space at home so the grandkids can come and stay over. These are the kind of real life things that enter into decisions that so often are forgotten in financial books.

Many people do have a fully- paid home that has in fact risen significantly in value, but they can’t turn it into a financial asset or split an income off from it. They could take out a reverse mortgage, they could take out a line of credit but of course, those have their risks. You’re turning compound interest into your enemy instead of your friend, and a lot of people are hesitant to do that even when it does make some sense.

You have to be well diversified. And I am not against home ownership. In fact I’m very pro home ownership. But I think it is unfortunate how many Canadians I cross paths with who have emphasized home ownership exclusively as they built up the asset of their net worth statement and that’s a tough one because they don’t have any other assets to fall back on or to generate an income in retirement.

Q7. I know from your talk at the HRPA conference and your book that you live in a modest 1300 sq ft. home and granite counters don’t turn you on. What do you like to splurge on?

A.7 Probably more experiences than stuff. I am not a stuff guy at all. I can’t remember the last time I bought anything significant on the stuff front. But I do like to go to sporting events and playoff games, especially of my beloved Detroit Tigers and I’ll take the odd trip and bring my kids along.

I tend to be not a big spender, not because I am cheap. In fact I am quite the opposite. It is more because I don’t get a big kick out of stuff. I like relationships. And my hobbies are relatively inexpensive. Golf, is a little bit expensive, but I’m into a hockey pools and I love to read.

When I do splurge it’s probably on a trip. A second big weakness I have is that I eat out often because I travel so much. I am always on the go, and I don’t know how to cook so I eat out a tremendous amount. I did a spending summary in the process of writing the second book and I went “holy smokers.” It’s not just the sodium content that’s killing me here, it’s the cost too.

Q8. When do you plan to retire?

A.8 Never, I love what I do. I like to travel. I don’t want to travel as much going forward as I get older because it’s a bit of a burden being in an airport every day. But I really do enjoy my career. There are a lot of new things I want to try. I honestly don’t see ever retiring, particularly from speaking. Speaking is a favourite part of my job and I don’t know why I would ever leave it.

Thanks David. It was a pleasure to talk to you today. I know our listeners will be delighted to hear your common sense advice. And if they haven’t already done so, I’m sure they will want to get their hands on a copy of your new book, The Wealthy Barber Returns.

My pleasure. Thank you for having me.