TFSAs benefit everyone, not just the so-called “rich”

Canadian Tax-Free Savings Account concept word cloud

By Jonathan Chevreau

No surprise that the Broadbent Institute — a newish left-leaning think tank that counterbalances the rightish Fraser Institute — has concluded in its report Double Trouble that only the “rich” would benefit from the promised doubling of annual contribution limits for Tax-free Savings Accounts (TFSAs.)

You can read the Financial Post’s front page story by Garry Marr (aka @DustyWallet on Twitter) here and the Globe’s version here.

I was particularly interested in the CBC website’s coverage, and especially the almost 900 reader comments that have been piling on. For instance, one reader said:

What was the big surprise here? you need money to make it?

Or this:

The government doesn’t lose anything. The NDP lose votes. The TFSA is one of the few programs the average guy and gal can use. The NDP should be all over the TFSA and tell Canadians how they would make it better faster. This is really bad electioneering on their part. The NDP should be trying to convince the public TFSA were their idea.

The coverage talks about the billions it will “cost” the government in lost tax revenue. We here at the Financial Independence Hub look at it a bit differently, of course. Remember, the original name for TFSAs were TPSPs, as in Tax-Prepaid Savings Plans. Unlike RRSPs, where you pay the piper at the end of the retirement-savings process, you’ve already paid tax on TFSA contributions before you’re able to contribute what’s left to your nest egg.

I argued in this Financial Post article in 2011 that Canadians, rich or poor, really don’t understand that those contributing to TFSAs have ALREADY paid their fair share of tax when they earned the income to come up with the TFSA contribution. Click through for the whole argument but I said that someone in the 46% tax bracket wishing to contribute $5,000 to a TFSA first has to generate earned income of $9,259, paying almost half in income tax.

TFSAs merely eliminate double taxation

TFSAs merely eliminate double and triple taxation. When you invest in non-registered or taxable accounts, not only does the capital you invest come after being subject to income tax, but all dividends, interest and capital gains generated from that capital will be further taxed each and every year.

As the piece also argues, TFSAs benefit low-income Canadians as much as the wealthy: in fact, one reason they were created was to help low-income earners save in a way they won’t be punished with OAS and GIS clawbacks in old age. As the earlier blog today by Ermos Erotocritou pointed out, there are many situations where a TFSA contribution may be wiser than an RRSP contribution.

In a subsequent exchange of emails, Erotocritou (a certified financial planner with Investors Group) said Ottawa made a mistake when they named it a Tax Free “Savings” account, when they should have named it a Tax Free “Investment” Account:

Ermos Erotocritou, CFP

If the government believes RRSPs are good for Canadians they should have the same view of TFSAs. Even though the government will miss out on tax revenue, the savings in future GIS and welfare payments will outweigh some if not all of the missing tax revenue short term. Human nature dictates that if someone “feels” richer, they are more likely to spend money on products and services. If Canadians start to feel better about their financial situation and spend more money (which they will have through their TFSAs) then the government will see an increase in consumption taxes such as GST, HST etc. I am in the same camp as you when it comes to investing in TFSAs. Canadians have to pay taxes on their earnings before they can invest in their TFSAs. Taxing TFSAs is equivalent to double taxation and will only curb people’s appetite to save for their future. Making it more difficult for Canadians to invest and save for their future is counterproductive in the long run.

This all comes down to politics, of course, which is beyond the scope of this site. Seems to me a lot of Canadians gave the Tories their vote based on the promise to double TFSA limits once the federal books were balanced. But you know what they say about politicians’ promises.

Maybe Ottawa should introduce a lifetime TFSA contribution limit

Double Trouble does at least make a distinction between young people who have the opportunity to contribute to TFSAs as early as age 18, and older folk who will only get a few years of contributions based on the yearly limit. The whole point of tax-free compounding over a long time horizon is that the young can truly generate huge sums if they max out contributions from day one and also invest wisely in diversified equity-heavy portfolios.

The report shows that a single person with a $5,500 annual limit could accumulate over a lifetime (52 years of contributions from age 18 to age 70) $690,000 at an annual rate of return of 3%, but that figure rises dramatically if you can generate better returns (likely with the help of a financial adviser). So at a 5% return, that single person could save $1.34 million and at 8% $3.99 million. It also shows how much dual-income couples would accumulate with an $11,000 limit: multiply the above examples by four.

The report does raise the question of whether TFSA contributions should be “bounded.” Perhaps so but the corollary of that is that near-retirees and baby boomers leaving the workforce should get parity too: if there is an upper limit to lifetime contributions to TFSAs, so should there by a floor. Instead of being limited by yearly contributions, why not just declare that investors of any age can contribute a lifetime amount of $500,000 or $1 million or whatever Ottawa deems fit? There’s no way retiring baby boomers will be able to contribute to TFSAs for 52 years and even $10,000 or $11,000 a year limits would never give them the power of tax-free compounding for half a century that young people can look forward to.

TFSA also compensated us for loss of $100,000 capital gains tax exemption

Another point that I didn’t see mentioned in Double Trouble is that the TFSA’s ability to shelter some capital gains tax in part compensates investors for the loss of the old $100,000 capital gains tax exemption. The report goes on at length about investors “cannibalizing” RRSPs and taxable investment accounts to fund TFSAs.

RRSP Deadline next week

Interesting too that the report notes an inflection point that occurred in 2012: that year total annual TFSA contributions hit $33.5 billion, exceeding RRSP “deductions” of $32.4 billion that year.

My stance on the TFSA is to take advantage of it while it’s still there. But since the TFSA is merely the mirror image of the RRSP and the RRSP has been around more than half a century, there’s little reason to fear the TFSA’s demise. A doubling of limits to $10,000 or $11,000 would clearly speed the financial independence of all Canadians, and really help retiring baby boomers as they slowly convert RRIFs and taxable accounts into TFSAs from the 60s to their 90s and beyond.

In the meantime, the RRSP deadline is next Monday. Here’s my take on that written for Motley Fool Canada.

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