How much would you need in a tax-free savings account (TFSA) to retire tomorrow?
That’s an interesting question because the TFSA’s tax-free withdrawals feature make the “retirement number” for an all-TFSA portfolio lower than a taxable one. RRSPs, despite being tax-deferred, become taxable upon withdrawal. CPP, defined benefit (DB) pensions, and other such instruments are taxable as well. So you can get by with a smaller balance if you’re using a TFSA for retirement rather than an RRSP.
With that said, retiring using just a TFSA has its limitations. Chiefly, contribution limits. Your TFSA room accumulates over the years in which you are eligible to open an account, at set annual increments. In recent years, the annual amount has been around $7,000. That’s a far cry from the $28,000 or so you could deposit into an RRSP as a high earner. So, retiring on just a TFSA could be practically challenging.
Nevertheless, the question of how much you’d need in a TFSA to retire tomorrow is one worth asking. In this article, I will explore that question, starting with the expert consensus on required funds, then make adjustments for the TFSA’s tax-free withdrawals.
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What experts say
In recent years, various Canadian banks, financial advisers and other experts have chimed in on how much liquid net worth you need to retire. Estimates have ranged from $500,000 to $1.5 million. We can use these estimates as a starting point.
In financial matters, it pays to go with the most defensive estimates. So, we’ll say that you need $1.5 million in liquid wealth to retire in Canada today.
Now, the estimates that went into producing that $1.5 million estimate all assumed that most of your retirement income was taxable. If you’re fully invested in a TFSA, then none of yours actually will be. So, in this very specific scenario, your “retirement number” is presumably lower than the usual one. How much lower? Let’s dive into that.
How much you save with a TFSA
The TSX currently yields about 2% while Canadian treasuries yield about 3%. So, investing in diversified/defensive assets, you’d generate between $30,000 and $45,000 per year. Add $1,000 per month worth of CPP into the mix, and it appears that such sums could in fact work for many Canadians – particularly if they live outside of the biggest cities.
Now of course, there’s a catch: if you get $42,000 to $66,000 a year from some combination of CPP and RRSP withdrawals, you’ll pay substantial taxes on it. If you get the same amount from a TFSA, then the taxes are zero. You pay no tax on your personal portfolio and what works out to about 0% on $12,000 worth of CPP income. By contrast, the taxes on $45,000 worth of bond interest would add up to about $6,000 per year. So, you could likely get by in retirement with less than $1.5 million in a TFSA – though with the $109,000 worth of contribution room that’s accumulated, it will take time to get there.
What to hold in a TFSA
Before concluding, I should touch on what kinds of investments tend to work well in TFSAs.
Generally speaking, those are stock index funds in combination with money market funds and/or GICs. A stock fund like the iShares S&P/TSX 60 Index Fund (TSX: XIU) gives you a highly diversified large cap portfolio with about 60 stocks. The diversification protects you from risk and the fund’s fee (0.15%) is low enough to avoid eating into your returns. Throw some money market funds and GICs in there to cushion you and provide dry powder during bear markets, and you could eventually build your TFSA to a level where you can retire off it.
