The Liberal changes to TFSA contributions were actually historic

In rolling back TFSA contribution limits, the Liberals broke a nearly six decade trend

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The new government wanted to make its first policy move in the House substantive and symbolic, but it also managed to make it historic. On Monday, the government gave notice that it will introduce a motion (a Ways and Means motion, to be precise) to cut the second federal income tax rate (applied to taxable income between $45,283 and $90,563) and create a new tax bracket applied to taxable incomes of $200,000 or more.

It’s true that this is the first time since 2001 that the basic architecture of federal tax rates has been renovated in a big way. It’s also true that if your taxable income is $45,000 or less, then this tax cut isn’t for you. Finally, yes, it’s true that a person with a taxable income of $120,000 stands to save more ($783) on their federal tax bill than a person with a taxable income of $80,000 ($582).

No, no, that’s not the historic part in my view. Look, 2001 wasn’t that long ago and I’ve written loads before about tax credits and public programs that benefit the better-off.

I’m talking about Clause 9 of the government’s motion that scales back the annual contribution room available to adults who open a Tax-Free Savings Account (TFSA) from the current $10,000 limit introduced for 2015 to the $5,500 annual limit that had done just fine before an election loomed on the horizon. Don’t forget, unused contribution room rolls over each year and there is still no lifetime cap on contributions. This means that between exemptions for home equity, lifetime capital gains rules and the TFSA, it won’t be long before most households in Canada are able to shelter virtually all of their assets from income taxation.

Back before the election, federal officials were at pains to explain that the increase in the TFSA room was well, really, really necessary, because, you see, over a quarter-million low-income Canadians (making less than $20,000 a year) had managed to max out their TFSA room under the $5,500 limit. ”Don’t you understand that these low-income people are just trying to put away some savings? Why do you hate people who are just… frugal?” With the national household savings rate stumbling along at about four per cent these days, shouldn’t we reward those who were saving roughly half of their modest annual incomes?

Well, no, and here’s why: From what I can see, the phenomenon that was offered as”‘the problem” to be fixed is likely temporary.

Looking at data from the 2012 Survey of Financial Security (Statistics Canada) when the TFSA was four years old (offering $20,000 of accumulated room for every adult in Canada) is instructive here:

– Singles and families aged 65 and older are far more likely to own a TFSA than their working-age counterparts (38-47 per cent versus 25-34 per cent respectively).

– Median TFSA balances amongst all working-age singles (under age 65) were just $5,000 (or 25 per cent of that limit) but median balances for singles aged 65+ were $15,000 (75 per cent of the limit). That’s the median, meaning that half of single seniors had TFSA balances between 76 per cent and 100 per cent of their allowable limit.

– Among couples and families, the age-related gap in median TFSA balances persists: $10,000 at the median for working-age households and $20,000 for those aged 65 or older.

– Within the working age population, there are also important age-related differences. Median TFSA values for couples or families aged 35-44 suggest median deposits of about $1,000 per year. But closer to retirement (age 55-64), household TFSA balances suggest median deposits of a little more than $3,500 per year, still well below the old $5,500 limit.

Those older households are, in the vast majority of cases, unlikely to be saving “new” money. Instead, they may well be shifting assets from one source—maybe perhaps proceeds from the sale of a family house that is now too large for their needs; or maybe this is coming from taxable RRIF income that is being recycled into a different and non-taxable registered savings account. Recall that the TFSA doesn’t offer a deduction for (most) deposits, doesn’t create new tax liability on withdrawals and is exempt for the purpose of working out the key income-tested senior’s benefit, the Guaranteed Income Supplement (GIS). Seniors with $20,000 in total personal income have too much income to receive the GIS now, but they may worry about exhausting their savings and needing the GIS later on. In these cases, shifting assets into a TFSA just makes good financial sense.

But that’s not what the TFSA was supposed to be for.

When it was introduced in 2008, the late Jim Flaherty cheerfully called the TFSA “an RRSP for everything else in your life.” His budget communications documents that year offered examples of people saving for all kinds of short- and medium-term uses like vacations and “rainy days.” The literature dating back to at least a 1987 study by the Economic Council of Canada (of which, Liberals, please give thought to reviving that creature to complement the work of a beefed-up Parliamentary Budget Officer) saw tax-prepaid savings as a way to stimulate more saving and investment by giving households choices when RRSP incentives fail. The literature doesn’t seem to have anticipated asset-shifting uses among the already-retired.

Unless the TFSA undergoes more dramatic changes like a lifetime limit, future generations of seniors are unlikely to worry much about annual caps limiting their ability to shift assets around to gain the best tax and benefit treatment. A person aged 55 today will have nearly $100,000 in TFSA room by age 65. And while today’s seniors with low income but some savings may feel cheated by an accident of policy timing, there are many other ways to address some of their concerns—flexibility on RRIF withdrawals for example.

But I still haven’t given you the punchline, have I?

The TFSA is just one among five separate tax-preferred and registered savings instruments in Canada. The first was the RRSP, introduced in 1957. When Kenneth Carter recommended scaling back RRSP limits in his 1966 report on Canadian tax reform, he was summarily ignored. Instead, we have, through relentless incremental policy choices, grown a tax and transfer system that is schizophrenic in its treatment of savings—rewarding people who already have money for saving it but often penalizing small savers. In the last 58 years, there have been exactly zero reductions to annual contribution room to any of these instruments—that is, until now.

By scaling back annual TFSA limits, the new government can keep the flexibility that tax pre-paid accounts offer without encouraging as much asset-shifting among the already comfortable. Promoting economic growth is the stated motive behind this renovation to the income tax brackets. If the government is serious about making that growth inclusive, then removing regressive incentives is a good start at breaking a 58-year trend.  But it’s just a start.