Published in the Financial Post on April 8, 2011
By Finn Poschmann
When Jon Kesselman of Simon Fraser University and I published "A New Option for Retirement Savings: Tax-Prepaid Savings Plans," the roadmap for what was to become TFSAs, we had high hopes for tax free savings accounts. I doubt we would have believed anyone who told us that in less than 10 years' time nearly five million Canadians would hold these accounts, but we would have agreed that if you built it, they would come -and Canadian savers did. For folks in the tax policy business, TFSAs are a grand slam.
TFSAs, of course, are the arithmetic nearequivalent mirror image of registered retirement savings plans, and appeared in their current form courtesy of Finance Minister Jim Flaherty's 2008 federal budget. Critics at the time came from several directions: that TFSAs were only useful to the rich was the message from one camp; some financial institutions were reasonably concerned about the cost of administration and training for staff who would market them; and many financial advisors saw them as nuisance distractions, because the proposed $5,000 annual limit on contributions was too small to handle worthwhile investment portfolios.
The class division question, whether TFSAs favour the rich over the poor, lies at the heart of why we thought developing TFSAs was good policy: because the old system did not serve the poor well. Today, more people understand that for low-income savers, the RRSP is often not the best tool. If your income is low, your tax rate is probably low, so the tax savings from deducting an RRSP contribution from taxable income is correspondingly low.
But for low-income households in retirement, the tax rate is almost always much higher, because provincial and federal seniors' benefits, such as the guaranteed income supplement, are clawed back (taxed back) from households with other income sources. And RRSP withdrawals are taxable income so, for many households facing high tax rates in retirement, saving is futile.
How often are TFSAs, as a matter of arithmetic, potentially the shrewder option? Work by Alex Laurin at the C.D. Howe Institute reveals the starkness of the issue. If people's incomes now are reflective of roughly where they will be in retirement, fully one-half of Canadian taxpayers would likely be better off financially if they were to save in TFSAs than RRSPs, specifically, taxpayers whose earnings are below the median. The upper half of the income scale is served well by RRSPs and, says the arithmetic, typically should maximize their RRSP savings, but they can benefit as well from additional taxrecognized savings via TFSAs.
For these reasons, TFSAs have been doing well: every major financial institution and many smaller ones offer them, and assets held in them will reach $20-billion this year.
But the edgier critique of the TFSAs, their being too small to be a worthwhile savings tool, is something that deserves a response. And it is an easy one: make the allowed annual contribution bigger, and let families open accounts on behalf of children under 18. Accordingly, Prime Minister Stephen Harper's announcement this week, of TFSA expansions to come, is a welcome one in an election campaign otherwise barren of sound new policy ideas.
So far, the economic platforms in the 2011 election have offered special tax breaks for one after another favoured activity, threatening to turn the Canadian system into the cheese boutique of tax policy -plenty of superficial choices, but not much really on offer. TFSA expansion, and the sooner the better, is different. Smart policy choices and sound options for saving and investment are always to be encouraged, and this simple savings plan is one of them.
- Finn Poschmann is Vice-President, Research, at the C.D. Howe Institute.
