Canadians Set To Stash Billions In New Tax-Free Accounts

by Mike Godfrey, Tax-News.com, Washington

12 September 2008

Canadian savers and investors are expected to squirrel away well over CAD100bn in new tax-free accounts, which were announced by the government in the last federal budget.

"The TFSA will kick in exactly when many Canadians are making the transition from passive savers to active savers," says Benjamin Tal, Senior Economist at CIBC World Markets in his Consumer Watch Canada Report.

Tal expects the TFSA market to mushroom to CAD115bn (USD107.5bn) by 2013 with cumulative tax savings of close to CAD2bn.

TFSAs, announced by Finance Minister Jim Flaherty in the 2008 budget earlier this year, will allow Canadians to invest up to CAD5,000 a year in tax-free accounts, beginning in 2009. Investment income earned within the account, including capital gains, will not be taxed, and withdrawals will be tax-free.

Tal notes that the TFSA plan is "arguably the most dramatic change in Canada's savings system since the introduction of the Registered Retirement Savings Account (RRSP)," although he thinks that the new savings vehicles should be viewed as a "companion to the RRSP" not a rival.

"The magic behind the TFSA is in its versatility. It is not simply a tax measure designed to help low-income Canadians, but rather a vehicle that can fit almost every Canadian, regardless of income or stage of life," he observed.

Tal expects about 400,000 low-income Canadians that currently contribute to an RRSP will switch to a TFSA. That translates into CAD2.5 billion in cumulative contributions from this group over the next five years.

"The current system discourages low-income Canadians from contributing to RRSP since their withdrawals after retirement might reduce the eligible tax credit and supplementary pension payments. In contrast, the TFSA is truly tax exempt, free of any clawbacks from federal tax credit and benefit programs," he said.

For seniors, Tal considers the TFSA an attractive channel to save beyond the current cut-off age of 71 for making RRSP contributions as TFSA account assets can be transferred to a surviving spouse or child, tax-free without affecting the beneficiary's contribution rooms.

TFSAs are also expected to benefit high earners who've reached their RRSP contribution limit, and want to build additional savings tax free. For the nearly 40% of paid workers that are covered by a registered pension plan, the TFSA can also help compensate for the pension adjustment that limits RRSP contributions.

Tal notes that another key feature of the TFSA is that its flexibility makes it ideal for immediate needs such as emergency funds as well as a tax efficient way for Canadians to finance consumption.

"The account can be accessed multiple times during one's lifetime to serve as emergency funds, and to bridge periods of income volatility. This liquidity feature of the TFSA plan is of great importance as it will probably work to limit or even eliminate uneconomical behaviour such as RRSP withdrawal. In fact, the liquidity feature is viewed by Canadians to be as important as the tax-free feature in the decision to open a TFSA," he said.

Tal believes that a significant portion of the money parked in TFSAs will be in cash and cash equivalent accounts.

Based on the experience of a similar scheme which has been operating in the UK since 1999, Tal predicts that half of high income individuals will contribute to TFSAs, compared to 30% with lower incomes.

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