Tuesday 26 February 2008

Hooray for TFSA! Canadian Federal Budget Delivers on My Wish List

Well, you read it here first on my Christmas Wish List 2007. Minister Flaherty has delivered on my request to institute a tax-free savings account just like the ISA that exists over here in the UK. Wonderful. These accounts are so simple and straightforward, they achieve much better than RRSPs the goal of getting people to save. There are no books written about ISAs, unlike the tome Preet Banerjee recently put out about RRSPs, because there's so little to write about. The worst thing about the new accounts is their awful acronym - TFSA. How the heck do you pronounce that - TaFSA? Didn't they learn with RRSP, where is the marketing savvy?

The $5,000 annual contribution limit is too low; better would have been double that and even better would have been four times higher, which would start killing off RRSPs. The "if you don't use it, you don't lose it" feature of the annual contribution limit is a great measure for added flexibility since many families with young children might not get the chance to save for a number of years.

I'd expect the new TFSA, as the info sheet suggests, to be heavily used by seniors, for instance for funding inheritances. The money can be put aside, grow tax-free and be non-taxable at death. While it is in the TFSA, it can serve as a safety cushion for unexpected health care costs and if not needed, passed along to the next generation. Increasing life expectancy could allow amassing a tidy sum.

In short, I believe the info sheet blurb is not too far off (except for the niggardly $5k) when it says "It’s the single most important personal savings vehicle since the introduction of the Registered Retirement Savings Plan (RRSP)."

It was nice to see our government paying attention to this humble blogger. I suppose they are waiting for the next budget to put in an annual tax-free capital gains exemption.


Anonymous said...

I posted about the TFSA as well and I am as enthusiastic about them as you are. The idea has been floating around for some time and it was part of the Tory platform for Election 2004.

I wouldn't hold my breath for a capital gains exemption, esp. in a minority situation. There will too much criticism that it is a "tax break for the rich".

CanadianInvestor said...

Where and when the idea came from is somewhat like the question of who invented television. Perhaps the Tories took TFSA from the Brits with their ISA, which goes back to 1999 and was itself preceeded by the PEP. In the larger scheme, we Canadians tend to look too exclusively to the US for examples and guidance. As I am discovering from being over here, the Brits have plenty of instructive experiences.

Sigh, you are likely right about the capital gains exemption. Perhaps over time, the mis-perception that capital gains are the preserve of the rich will diminish. More and more people are being forced to become investors to make up for the decline of defined benefit pensions and as soon as they do, they certainly become aware of, and leery of, capital gains taxes.

Anonymous said...

The $5000 limit per year sucks for us older folks but think about the 18 year old stating out - gaining $5000 per year in contribution room. At 18 and into his/her early twenties they'll be amassing significant savings space that won't be used until he/she starts full time employment.

The TFSA is a great savings and investment vehicle. I only wish it had started when I was 18 and I had all that accumulated tax-free savings room.

CanadianInvestor said...

Don't know how old you are but given life expectancy that extends well into the 80s if you survived your turbulent youth, then you could still have several decades of TFSA accumulation ahead.

Anonymous said...

Call me duumb but what the hell is an ISA?

Watched Global National online yesterday and the general take was "it's a stupid idea since no one has five grand floating around".

CanadianInvestor said...

Rob in Madrid,
ISA stands for Individual Savings Account. People who are UK residents for tax purposes, which includes mostly Brits but also any foreigner who spends more the 183 days in a year in the UK, are allowed to put up to £7000 annually (going up to £7200 in April) into an account very much like the TFSA. There's no tax to pay on interest income or capital gains within the account and dividends only get dinged 10%. It is after tax money that goes in and the money can be withdrawn tax-free at any time. One big difference with the TFSA is that a contribution, once withdrawn, cannot be put back in later. Another is that the annual contribution cannot be carried over from year to year so you either use it or lose it. There is no such thing as an RRSP here in the UK. Given that £30,000 is considered a good salary here, the ISA's £7k limit is pretty generous.

Whether almost no one has $5k to put into one of these plans to me seems like a "you can lead the horse to water but you can't make him drink" issue. It doesn't need to be all of the $5k, of course -any amount can go in and since the contribution room carries over and accumulates, that can be very useful later on. Many families go through a life cycle where there is no spare cash at the beginning while raising kids and paying off the mortgage but later there is.

It will remain to be seen what the take-up is. The utter simplicity of the tax rules is one of the key features as far as I'm concerned. I cannot see a downside there.

How the financial institutions administer the plans is another as yet unanswered questions. Will they impose fees and administrative restrictions that take away much of the benefit? e.g. to withdraw from an RRSP, most of the banks/brokers charge $25 per withdrawal. If they do the same for the TFSA, that will severly hamper their popularity.

Patrick said...

I wouldn't say the $5000 limit is small. First, that's after-tax money, so it's not comparable to $5000 of RRSP contributions. Second, it can be carried forward, so when you retire at 65 you should have $235,000 of room. Your asking for "four times that" would allow people to save almost a million dollars tax-free, which I think is a bit much. Somebody has to pay some tax at some point!

CanadianInvestor said...

Patrick, You are right that $5k annually can add up over a very long period, if it stays around, of course. But the total amount is over a lifetime of saving. What is more, even a million dollars today on its own (for those who do not have a separate pension plan) doesn't fund a very luxurious lifestyle - e.g. a 4-5% withdrawal rate, which is the max rule of thumb to make sure it last for up to 30 years or so before running out, gives .04 x 1 mill = $40,000 a year pre-tax.

I'd be willing to give up the RRSP entirely for a four times TFSA. The TFSA is so flexible and simple it really appeals, so I want more of it.

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