May in the Yukon brings sunny skies, swans and—thanks to the April 30 income tax deadline—desperate resolutions to find a way to pay less next year.
This year the helpful folks in the federal government have given our springtime hopes a fillip with a new acronym they have added to our investment portfolios: the Tax-Free Savings Account.
“Tax-free” sounds good. Certainly the investment community did a good job telling us about TFSAs during the annual Retirement Savings Plan jamboree in February.
And spin doctors for the federal Conservatives in Ottawa call it “The single most important personal savings vehicle since the introduction of the Registered Retirement Savings Plan.”
But how excited should we get about TFSAs?
Is it worth rushing out to open an account while memories of tax-time are still fresh?
To start with, a TFSA is an account where you can invest up to $5,000 per year and pay no tax on your investment gains (if any, these days).
TFSAs are the Bud Lite of tax-sheltered investments. Your contribution limit is $5,000 per year, a quarter of the RSP maximum. Unlike RSPs, they don’t have an immediate tax credit, but in later years they do shelter future investment gains from tax in the same way RSPs do.
The flip side of this is that you can withdraw money from your TFSA at any time without paying additional tax.
What does this mean in terms of money saved?
If you were in a 40 per cent tax bracket, invested $5,000 in a TFSA and managed to earn eight per cent, then you would save $160 per year in tax. If you were in a 30 per cent bracket and managed only a four per cent return, then you’d save $60.
Of course, if your investments go down in value you save nothing.
So don’t call the Porsche dealership just yet. These are not large numbers. But they are still favourable.
If you dutifully contribute $5,000 per year for 20 years, then your lifetime tax savings can build up to more than $20,000.
In the investment alphabet, however, TFSA comes after CPP, RSP, RESP and (depending on your situation) life insurance.
Once you’ve paid off your mortgage and your car loan, ensured your CPP and pension contributions have been made, topped up your RRSP, made a spousal RRSP contribution, put $2,000, or more, per kid into your RESP, optimized your life insurance strategy and taken advantage of the Yukon Small Business Investment Tax Credit, then you should definitely tell your butler to take $5,000 out of petty cash and top up the TFSA.
Fortunately, if you don’t have $5,000 in petty cash hanging around this year, you can carry forward your allowance to future years.
Why did Ottawa go to the trouble of introducing a minor, even if worthwhile, investment vehicle?
Cynics might note the TFSA allowed the federal Conservatives to add a tax-cutting plank to their platform, while knowing that it wouldn’t cost much money since few people would actually use it.
Others might say that it helps address the low level of savings in Canada, although the impact will be minimal.
The existence of the TFSA a few years ago would hardly have prevented those now suffering from excessive debt from having purchased the monster house or 4×4 (with twin snowmobiles and sled trailer) of their dreams.
One important policy advantage of the TFSA is that the federal government does not count TFSA wealth or income towards income-tested federal social programs, such as Old Age Security, Employment Insurance or the Canada Child Tax Benefit.
Economists have long criticized some of these programs for encouraging dependency, since they penalize recipients if they have savings. Hardly an incentive to save for the long run.
The downside from a public policy point of view is that this kind of minor fiddling with the tax code adds a hidden cost of complexity across every taxpayer’s return.
The extra work might be good for accountants, but the rest of us will be puzzling over yet another badly worded chapter in the tax guide.
And because of the cost of all the loopholes, the average tax rate for everyone else must remain a bit higher.
So, in the end, should we all open TFSAs?
First of all, before making the decision you should come up with an overall financial plan. Consult a professional if you need to. For most people, the best idea will still be to focus on the mortgage and making full RSP contributions.
However, there are two groups of people that should think further about TFSAs: the rich, and those who think they might be applying for an income-tested social program sometime soon. If you already have a sizeable non-RSP investment portfolio, and have ticked the other boxes on your financial plan, you can start moving $5,000 per year into a TFSA.
Or if you have a bit of money, but are worried Employment Insurance might be in your future, sheltering your nest egg in a TFSA could help you avoid an unwelcome clawback of your benefits at tax time.
And if you do open a TFSA, be sure to choose an institution that doesn’t charge a fee.
If you’re only saving $60 per year, you won’t want to share it with your bank.
Keith Halliday is a Yukon economist and author of the Aurore of the Yukon series of historical children’s adventure novels. His next book Game On Yukon! appears shortly.