Memo to Liberals: lots of older middle-class Canadians have $10,000 TFSA capital “lying around”

The Financial Post ran an op-ed written by me today (A10), titled simply How to Max Out your TFSA. We’ve written on this topic before of course, but it specifically addresses an oft-repeated Liberal comment that few middle-class Canadians have “$10,000 lying around” for a TFSA contribution.

On the contrary, I argue, many middle-aged middle-class Canadians have hundreds of thousands of dollars in non-registered or “open” investment accounts, money that is subjected to annual rounds of tax on interest and dividends, and often capital gains, and which would love to find a tax-free home in a Tax Free Savings Account.

Similarly, many seniors already in retirement have large RRSPs or RRIFs that can also be a source of funds for a TFSA, once withdrawals are made and a one-time tax hit is sustained.

In fact, this weekend, I spent time with a 98 year old friend (a woman), who proudly informed me she recently put $10,000 into her TFSA and is saving up from her part-time job to put in another $5,000. Why? She felt she needed a bit of cushion in case some medical problem arises.

As the end of the FP piece notes, there are plenty of other potential sources too, including sale of a principal residence (perhaps in a downsizing situation), severance payments, life insurance proceeds, sale of a business, lottery wins and — this one’s for you, Justin — inheritance.

Gordon Pape on TFSA income investments

In a related column in the Globe & Mail last week, TFSA author Gordon Pape wrote an interesting piece about how TFSAs are now large enough that they can start spinning off tax-free income. His piece looked at ten Canadian dividend-paying stocks like BCE.

Gordon and I will be two of five speakers this Wednesday evening at The Financial Show at the Mississauga Convention Center. Details here.

For continuity and archival purposes, below is the op-ed on TFSAs, with a few subheads added:

By Jonathan Chevreau

I can understand that a relatively youthful Justin Trudeau doesn’t seem to fully understand how older investors can “find an extra $10,000 lying around” for their TFSAs but you’d think his deputy leader, Ralph Goodale, would get it.

The other day, Goodale – who is a former federal Minister of Finance – wrote an opinion piece for the Financial Post bearing the headline “Who will this help?”

Right at the end of the piece, Goodale seemed to be directly channeling Trudeau when he said “it’s just not realistic to expect many middle-class families to have an extra $10,000 lying around every year, after taxes, to enable them to fill up a higher TFSA contribution maximum.

Earth to Justin

When Trudeau delivered a similar quote shortly after the April federal budget upped the annual TFSA contribution limit to $10,000, I tweeted a snarky “Earth to Justin Trudeau” remark to the effect there are plenty of ways the middle class can come up with $10,000.

It may not be “lying around” as cash on the sofa or tucked away in a mattress but Goodale is old enough to realize that many older investors have large non-registered investment portfolios — as we have written in earlier columns, one excellent way to come up with $10,000 is to transfer the securities in kind. See earlier columns for the complex tax aspects of such transactions.

Meanwhile, those already in retirement (rather than still saving for it) also have a handy way to find $10,000 for a TFSA contribution. Seniors 71 or over are already forced to make annual – and taxable – withdrawals from their Registered Retirement Income Funds or RRIFs. Yes, the budget did cut the required withdrawals after age 71 by about 26% but this still means seniors will be slowly eroding their capital, since few can match even the 5.28% annual withdrawal rate for 71-year-olds at current interest yields and dividend yields.

Transfers-in-kind

Fortunately there’s no law saying that after paying tax on those withdrawals, the money must be spent. The remaining capital is as good as “money lying around,” and can be transferred to a TFSA. At that point, the capital would be free to grow tax-free for as long as its owner lived.

I’d argue both near-retirees with large non-registered investment portfolios as well as seniors with large RRSPs and RRIFs are very much a part of the Canadian middle class who can be helped by these larger TFSA limits. The reason most RRSPS get large in the first place is that middle-income salaried employees are desperate to alleviate a tax bite that in many provinces now exceeds 50% on the last dollar earned. Clearly, these people yearn to keep a bit of investment capital free of the taxman’s clutches, even though – as retired actuary Malcolm Hamilton has often argued – it’s largely futile for Canadians to put money in non-registered or taxable plans.

Saving in taxable plans “futile”

Why futile? Remember, in order to put $10,000 into a non-registered account – or indeed into a TFSA – you have to earn perhaps $15,000 in the first place and pay $5,000 income tax to net the $10,000. In a sane world, the government would be content with the initial income tax and let the investor enjoy the fruits of delayed gratification on the remaining capital.

But instead, Ottawa subjects that already-taxed-once capital with additional annual rounds of tax on interest income, dividend income and in some cases, capital gains, for as long as the investment is held. And once it is ultimately spent, they will pay consumption taxes (GST or HST) on whatever good or service is purchased. Futile? I’d say so.

TFSAs are Tax-PREPAID plans

It was to redress this unfair system of double taxation on capital that the TFSA was created. Remember the original name for TFSAs was Tax Prepaid Savings Plans or TPSPs: the key phrase is Tax-Prepaid. TFSAs are not some magical tax gift: unlike an RRSP contribution, you’ve ALREADY paid tax on capital when you put money into a TFSA. TFSAs are a gift from Ottawa only to the extent that they beat the alternative in merciless taxation: the tax treatment on non-registered investments, described above.

Other common sources of capital

Finally, apart from RRIFs and non-registered savings, I’d remind Mr. Goodale and Mr. Trudeau that there are several other possible sources of TFSA money for the beleagured middle class: inheritances (Justin should realize the truth of the latter), lottery wins, severance packages, proceeds from the sale of a business or a principle residence, life insurance benefits and no doubt several other sources.

Jonathan Chevreau runs the Financial Independence Hub and can be reached at jonathan@findependencehub.com.