The F factor

The saga of F has been well documented here. Since he died more than five years ago, Jim Flaherty’s name is rarely heard. Too bad. He had some guts. And while in my final political days he joined the forces repelling and ejecting me, respect is due. The elfin deity left more good than bad behind him.

That brings us to the TFSA. Readers of this blog and its precursor helped me craft a far-reaching report on tax reform in 2007 which was presented to Flaherty. A retirement vehicle modeled on the American Roth IRA was one of the suggestions. F adopted it in the 2008 budget and it became law the next year.

So here we are. Ten years on. Already there are suggestions bubbling up that a collar should be put on this thing. So time for a blunt review.

My original idea was simple: let people put after-tax money into a vehicle where it can grow free of tax until they retire, providing an unreported income stream. Make it democratic. Not linked to income. Everybody gets the same ability to contribute. Because no tax deduction is earned when funds are deposited, the money flowing from it isn’t counted as income. No impact on CPP or OAS.

F changed that a bit. He turned it into a savings vehicle, not a retirement one, allowing withdrawals at any time with the ability to replace them in the future. Not losing contribution room was a good wrinkle. Calling it a ‘tax-free savings account’ was not.

Before he shuffled off this mortal coil, F raised the annual contribution limit from $5,000 to $10,000. The very first act of the incoming Trudeau government was to slash it back, then add some inflation-indexing. This year the amount you can stuff into a TFSA is six grand.

In a decade the contribution room has grown to $63,500, or $127,000 for a couple. Some people, though, have hundreds of thousands in their plans because they threw high-risk growth assets in there. The CRA has chased those who have used TFSAs to shelter day trading, or professional traders trying to game the system – but that’s not the big issue. Instead, this money machine is being used and abused by a nation of investment wusses.

These days over 70% of people have opened a TFSA, which makes them more popular than RRSPs, marriage or Liberals. The average amount held is about $28,000 and last year the average contribution was $4,800. That’s good. But far too many of we little beavers are squandering this opportunity.

Four in ten consider their TFSA just an emergency fund. Eighty per cent of overall TFSA money is in low-interest GICs or savings accounts. RBC found investors 55 or older have 67% of their money in those brain-dead assets, with just 7% in ETFs. The rest is in high-fee mutual funds or high-risk single stocks. Yikes. What are they thinking?

Anyway, something predictable has happened. People who understand what a gift the TFSA is – for turning after-tax money into a never-taxed stream of proceeds from growthy assets which will not cause government benefits to be clawed back – have been doing just that. Thick-as-a-brick folks, or those who misunderstand risk or are financially illiterate, have been using TFSAs as savings accounts. Thus a dramatic divide has developed, even though this vehicle has been equally and democratically available to everyone, regardless of their income level. Data shows lower-income people keep most of their savings in RRSPs, which provide scant tax savings and can erode retirement benefits. Meanwhile higher-income people have TFSAs growing like weeds.

It will be only another five years or so before the aggregate TFSA room climbs to $100,000 per person. At that time a couple in their early forties holding the maximum amount and making yearly contributions growing at 7% will have $1.26 million in tax-free accounts at age 65. That will throw off an income of about $76,000 per year in retirement which will not be counted as income, allowing full CPP and OAS collection. In other words, a household income of at least $110,000, with zero tax.

So, this is why some people think things need to change. “The federal government should consider capping lifetime contributions of TFSAs — at around $100,000 to $250,000 — to avoid creating more TFSA millionaires while shortcomings persist among lower-income Canadians,” says Ottawa statistician Richard Shillington. He also recommends that Ottawa start topping up the TFSAs of lower-income people with tax money, like you get with your kid’s RESP.

Is this possible?

Of course. Federal taxation policy and budget priorities have been leaning left for a while, as evidenced by the gutting of F’s annual TFSA contribution. Last year Ottawa launched an assault on the self-employed and professional corporations. Now a change to the capital gains rate and treatment of dividends is being considered. Meanwhile the feds pay people when they have children, and tax them more when they succeed. So a TFSA limit is no stretch.

What to do?

Easy. Max your contribution room. Now. Invest for growth. Put more aggressive portfolio assets in there while keeping the fixed-income ones in your RRSP. Fund your spouse’s tax-free account. And your adult children’s. Make the 2020 contribution in the first week of January. Never be satisfied collecting interest inside your plan. Never take money out. Inflate that sucker to obscene, gargantuan proportions. And harbour not one shred of guilt. This is democracy, at work. F would smile.