TFSAs due for tweaking, says CD Howe

Investment product has undergone phenomenal growth, but some changes can make them even more useful

TFSAs due for tweaking, says CD Howe

Tax-free savings accounts have grown massively since their introduction a decade ago, and a few policy changes can make them even more attractive to investors, according to a new paper from the CD Howe Institute.

“After only eight years of existence, the fair-market value of all investments in TFSAs reached almost $233 billion by the end of 2016,” wrote Alexandre Laurin, the institute’s director of Research and author of the paper. “By comparison, this is about 20 percent of all assets held in Registered Retirement Savings Plans, Registered Retirement Income Funds and Locked-In Retirement Accounts.”

Laurin noted that the number and share of taxfilers holding a TFSA has undergone particularly strong growth among younger age groups, with 50% of 25- to 34-year-old Canadians having one. That nearly matches ownership in the 65-and-over category, where the investment product’s popularity is strongest at 57%.

“Interestingly, younger individuals are drawn to TFSAs at a rate fairly similar to that of older individuals,” Laurin said, noting a bigger age gap in utilization of RRSPs tilted toward more elderly Canadians.

Laurin also noted that $55 billion in total contributions were made to TFSAs in 2016, compared to $42 billion that went into RRSPs. Annual TFSA contributions have exceeded contributions to RRSPs since 2013, and the share of tax-filers making TFSA contributions has accelerated from 2009 to 2016, the latest year of data reflected in the report.

“[A]bout four out of 10 dollars of TFSA contributions since 2009 (net of withdrawals) might have been at the expense of unmade RRSP contributions,” Laurin wrote, referring to findings from research published in the Canadian Tax Journal this year. However, he also said there’s still considerable overlap in usage of TFSAs and RRSPs among households.

Laurin noted that among seniors, TFSAs are evidently popular as a third of all taxfilers aged 60 and above contribute to a TFSA, with an average contribution of over $9,000 in 2016. Almost half of households aged 60-plus hold a TFSA, with most of those having a household income of less than $60,000. “For seniors, TFSAs are a tax-effective tool to decumulate their retirement capital and insure against longevity risk,” he wrote, noting the need to shield income from fixed-income assets given low interest rates.

But TFSAs could be made even more useful, he said, with a few changes. For retirees, he recommended allowing the purchase of life annuities — including advanced deferred life annuities (ALDAs) and variable payment life annuities (VPLAs), which are being considered under draft legislation — within a TFSA, which would shield the interest portion of the payouts from tax. He also encouraged legislation that would permit someone to not just inherit their deceased spouse’s TFSA assets, but also utilize any unused TFSA contribution room within certain limitations.

Laurin also referred to a previous proposal to let low-income workers access a “tax-free pension account” (TFPA) which would effectively provide a tax-prepaid option — that is, an option where withdrawals aren’t taxed because the income used to fund it has already been subject to personal taxation — for long-term retirement capital accumulation. A complement to TFSAs, TFPAs would benefit from the same creditor protection enjoyed by pensions and RRSPs.

Finally, he noted that under the Canada-US Tax Treaty, dual citizens of Canada and the US who hold RRSPs may defer taxation of income earned in the plan in the US until withdrawals are made, but no such concession is made with respect to TFSAs. Dual citizens are also spared from paying withholding taxes on dividends earned within their RRSPs, as well as other registered plans administered to provide pension, retirement, or employee benefits; the exemption doesn’t apply to TFSAs. 

“While this may be easier said than done, the federal government should make every effort possible to resolve these two US tax irritants,” Laurin said.


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