TFSAs – Who Benefits?

There has been a lot of controversy over the Conservative government’s plan to double the TFSA contribution limit. But a lot of people will benefit. Are you one of them?

The budget hasn’t even come down yet and already there is a chorus of media criticism of the government’s apparent determination to fulfill the promise made in the 2011 election campaign to double the TFSA contribution limit when the budget is balanced.

There are two major objections to the idea. The first is that it will severely compromise federal and provincial government revenues in the future. The second is that the increase will mainly benefit the wealthy.

I addressed both these points in a column I wrote a few weeks ago. At the time, I commented that it’s too soon to make any assumptions as far as the revenue impact is concerned because we don’t have any clear withdrawal history yet. The latest numbers suggest that TFSA withdrawals are accelerating at a faster pace than contributions. If that trend continues, it suggests that the amount of money being tax sheltered in these plans could be less than expected.

As for who benefits most, certainly people with more money are at the front of the line since they are in the best position to contribute more. But that does not necessarily mean the highest income earners – in fact, many of those people employ highly sophisticated tax planning strategies and don’t really need TFSAs at all, which represent chump change to them even with enhanced limits. Here are some of the groups that will stand to benefit the most if the limit is raised.

Seniors. After your 71st birthday, you can no longer contribute to RRSPs. That makes TFSAs the only game in town for older Canadians. People who don’t need all the income from their pensions and mandatory RRIF withdrawals can shelter the extra amount in a Tax-Free Savings Account. Raising the contribution limit gives them more flexibility to do that. There’s also an argument to be made that since TFSAs are very new (started in 2009) older people should be given extra contribution room to compensate for the fact they have fewer years to use the plans.

Savers. Anyone who has some money put aside in a bank savings account or non-registered brokerage account should welcome an increase in the contribution limit. It would create an opportunity to move more of that money into a tax-sheltered environment. And since the savings are already in place, it won’t require any financial sacrifice.

Young people. I’ve always advised young people to start saving early to take maximum advantage of the power of compounding. Until recently, the RRSP was the best way to do that, but it has drawbacks. Most important in this case is the calculation of the tax deduction. The higher a person’s income, the greater the deduction – if any savings vehicle truly benefits the rich it’s this one. A young person in a low tax bracket could end up paying a higher rate of tax at the time of withdrawal than the deduction received on making the contribution. Of course, it is possible to defer claiming the deduction until income is higher but my experience suggests not many people are aware of that. Raising the TFSA limit gives these people a more attractive long-term savings option by ensuring they won’t be hit with a high rate of tax when they take out the money.

Income splitters. When one spouse gives the other money to invest, income attribution rules normally apply. TFSAs are exempt, however. This means you can give the lower income spouse the money needed to make a full TFSA contribution, with no penalty. The higher the contribution limit, the more effective this income-splitting technique becomes.

Low-income Canadians. One of the key arguments made by the C.D. Howe Institute in advocating the creation of a TFSA-style plan was that it would eliminate the unfair treatment of low-income seniors who have saved some money in RRSPs but qualify for the Guaranteed Income Supplement (GIS). Under the current rules, all RRSP/RRIF withdrawals are treated as income. That means for every dollar taken out of one of these savings plans, a GIS recipient loses $0.50 worth of benefits. In effect, these people are being penalized for saving. TFSA withdrawals are not treated as income for this purpose, so no loss of benefits takes place. An increase in contribution room will give these people more opportunity to protect GIS benefits and will also help Old Age Security recipients avoid the clawback.

Yes, it is true you have to have enough money to make the contributions. But to assume that only the super-rich are in that position is, I believe, an oversimplification. There are a lot of Canadians who stand to benefit.

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