Jim Flaherty may be gone, but TFSAs will live on

National Post


One of the legacies that Jim Flaherty has left behind from his eight-year term as Minister of Finance is the Tax Free Savings Account. But with his recent resignation, will the TFSA survive in the long term and become a permanent part of the Canadian tax-assisted retirement savings landscape or is it in danger of being eliminated or perhaps curtailed now that its champion has left the building?

As for its future, can the tax base withstand the Conservatives’ 2011 election promise to double TFSA contribution limits once the budget is balanced?

TFSAs were launched with much fanfare by Mr. Flaherty in the 2008 federal budget and became available to Canadian taxpayers in 2009.

“In one fell swoop, [Finance Minister Jim] Flaherty has set the stage for a much simpler tax system and a much more advantageous investment environment for income-oriented Canadian investors,” Andrew Teasdale of the Tamris Consultancy said at the time.

While the uptake started off rather slowly, with some confusion over contribution limits and how the TFSA fit into individual financial plans, it has become an integral part of the tax system.

In his final budget this year, Mr. Flaherty estimated that by 2030, in combination with other registered plans, the TFSA would permit more than 90% of Canadians to hold all their financial assets in tax-efficient savings vehicles.

The initial annual contribution limit of $5,000 has now risen to $5,500 and unused contribution room can be carried forward to future years such that the cumulative limit for someone who has never contributed can be as high as $31,000 in 2014. As a bonus, any withdrawals from a TFSA get added back to your contribution room the following calendar year.

As of 2012, Statistics Canada says 4.9 million family units held almost $66-billion of assets in TFSAs. Although this represents a small portion of total assets (0.7%) held by Canadians, one-third of family units had TFSAs with a median account value of $10,000.

The introduction of the TFSA can be traced back to a 2001 C.D. Howe commentary paper written by Jonathan Kesselman and Finn Poschmann in which the concept of a “tax prepaid savings plan,” (TPSP) was proposed for the Canadian tax system.

The term “pre-paid” refers to the fact the tax on the contributions is paid in advance. The TPSP model addresses the double taxation problem associated with non-registered savings wherein you pay tax when you earn income and then pay tax again on the growth of that income when it’s time to spend it.

While the Liberal government announced they were studying the merits of introducing a TPSP in its 2003 budget, Minister Flaherty chose to call the plan a TFSA when it was formally introduced for 2009.

Yet some critics believe the name itself may partially explain why more taxpayers haven’t embraced it. After all, the “S” in TFSA stands for “savings” and many Canadians don’t realize that a TFSA can also be used for long-term investment purposes. Pretty much any investment that you can hold in your RRSP, such as stocks, bonds, mutual funds and ETFs, can be held in a TFSA.

While some Canadians love their TFSAs, their popularity doesn’t come without a substantial cost to the federal purse. A Finance Department report last month said the “cost” of the TFSA, measured in terms of lost government revenue, was $65-million in 2009, $165-million in 2010 and $160-million in 2011. It is projected to have cost $295-million in 2012 and $410-million in 2013.

Doubling the limit to $10,000 once the budget is balanced could be even more costly. In 2012, Kevin Milligan, a professor of economics at UBC, ran a long-term simulation of what a “mature” TFSA would cost in terms of lost government revenue should the TFSA limit be doubled. He estimated the cost could result in a decline of 6% in the federal personal income tax base.

Yet the TFSA, even without a doubling of the current limit, remains a key part of the tax system, and won’t go away. By the next generation, the TFSA will have become part of the fabric of our tax landscape, especially as a means of encouraging lower income Canadians to save for retirement. After all, the traditional vehicle of retirement savings – the RRSP – is of little benefit to those with very low marginal tax rates and becomes even more problematic when the retirement funds are ultimately withdrawn and included in income, often at higher marginal effective tax rates than the individual faced in the year of contribution.

The TFSA, in conjunction with the RRSP, provides the flexibility to allow an individual to at least guesstimate which vehicle is ultimately best suited for long-term retirement savings.

After all, it’s in the government’s interest to encourage more retirement savings by Canadians, and the TFSA is a welcome addition to the retirement planning toolbox.