As the details of the budget continue to sink in, the new Tax-Free Savings Account (TFSA) is emerging as the clear winner in terms of savings for Canadians.
Most observers say the TFSA should be of interest to all Canadian workers. High-income workers who are already contributing the maximum to their RRSP now have room for an extra $5,000, tax-free; seniors and lower-income workers are free to contribute past age 71 (the RRSP limit); and funds withdrawn from a TFSA will not reduce the Guaranteed Income Supplement or Old Age Security pension.
“No question about it. The TFSA is a great new savings vehicle,” says Jerry Loterman of Hewitt’s retirement practice in Toronto. “It addresses many of the previous concerns about capital gains taxes.” He’s surprised at how liberal the savings vehicle is, in that contribution room can be carried forward indefinitely. “All types of investment income will be tax exempt, the amount is not income-related, and all contributions including investment income can be withdrawn and then that amount added back to contribution room,” he says. “This is one of the simplest designs to come from the government in a long time.”
Malcolm Hamilton, actuary and principal with Mercer is similarly upbeat. “I suspect this will be the largest change to the system since the RRSP was introduced in 1957,” he says. “The RRSP was largely ignored until it gained traction, and I hope the TFSA learning curve will be shorter.”
Aside from the personal savings perspective, questions have been raised with regard to the TFSA’s applicability to group savings plans. Eckler Ltd. issued a statement Wednesday highlighting potential administrative and communication burdens for some plan sponsors, as employees may rush to change their RRSP contributions into the TFSA. “Sponsors will need to weigh these potential risks and to evaluate the services and pricing available from plan providers in deciding whether to introduce a group TFSA arrangement to employees,” it says.
Hamilton supports this view, explaining that due the novelty of the vehicle, there’s potential for confusion as the vehicle has varying advantages for different demographics. “Some of the changes will be challenging,” he explains. “Until now, if a worker contributes 5% to an RRSP there’s not much concern about where the money should go, whether RRSP or pension plan. Might these employees be better off if the money went into a TFSA? For young people and lower-income workers, yes. It provides a better avenue for a down payment on a home, which is the best use of savings in their early lives. Employers should think about where this new vehicle fits.”
Loterman believes the TFSA would probably work as a group vehicle. “Whether or not employers will want to contribute will depend on the regulations related to the TFSA,” he explains. “However, a group TFSA would make an excellent replacement vehicle or additional savings vehicle in a retirement savings or other capital accumulation program with respect to contributions that exceed RRSP or pension plan limits, or for unused flex credits. Payroll deduction, and the tax sheltering of all investment income would be very attractive to employees, even if the employer does not contribute to the account.”
Greg Hurst, Principal at Morneau Sobeco suggests that instead of viewing the TFSA as an alternative to an RRSP, workers would be wise to use a combination of the two to gain the most benefit. “The TFSA, in concert with RRSPs, will also allow some significant new tax-planning strategies,” he explains. “One potential tax-planning strategy is to intentionally leave RRSP room, and use additional savings capacity to fund a TFSA.”
When individuals are faced with a significant year-over-year variation in income (for example, self-employed persons, persons receiving severance packages, forced sale of shares, etc.), the available RRSP room can then be utilized to maximize tax-efficiency relative to additional levels of income, says Hurst. “If necessary, TFSA funds can be withdrawn for deposit to the RRSP—thus incidentally also creating TFSA re-payment room. Similarly, in a low-income year, RRSP withdrawals can be made at minimum tax levels, and then swapped into a TFSA with available room.”
As word spreads about the benefits of vehicle, some observers say this may be a watershed moment. “It’s a great thing,” says Hamilton. “It’s the new RRSP.” For more federal budget coverage, click here to read our special online section, Budget 2008: Special Report.
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