Historicist: Life in Wartime
Elsewhere in the Ist-a-Verse
Photo by jpghouse.
The incentive to spend money is enormous: there’s always a bigger latte, a newer iPod, and a better apartment waiting around the corner. Saving money is laborious and—let’s face it—boring. Unfortunately, easy access to credit and rising property values have turned the West into a population of grasshoppers, just starting to get a taste of the financial winter coming. Although the new federal budget has underwhelmed, the government has provided an interesting way to save in the tax-free savings account (TFSA), set to start next year.
The TFSA allows Canadians to contribute $5,000 of their post-tax income annually into a special account where any gains or interest accrued won't be taxable. The account is extremely user-friendly for two reasons. First, unused space for contribution rolls over, so that if you don't have the money for 2009, for example, you can contribute up to $10,000 in 2010. Second, unlike an RRSP account, if a withdrawal is made from a TFSA, the value of the withdrawal is returned to the contribution limit so it can be contributed back later. If you contributed $4,000 in 2009, but pulled out $2,000 for an emergency, you would still be able to contribute $3,000 for that year.
Of course, actually having the $5,000 to contribute helps. The government suggests that Canadians in the two lowest tax brackets would soak up over three-quarters of TFSA benefits—presumably as lower-income Canadians could choose the new account over an RRSP account because of its flexibility in contributing and accessing money. However, criticism has arisen that the benefit is moot since many lower-income Canadians cannot afford contributing to TFSA.
If you’re deciding between contributing to your RRSP account versus the TFSA, the answer is yes. You're best off contributing to both if you can. Otherwise, estimate the tax rate you expect to pay in the future. A contribution to a TFSA is more worthwhile if you expect your current tax rate to be lower than the tax rate when you withdraw the money—essentially the situation debt-free university students and new graduates are in. As well, there’s easier access to money in a TFSA since the tax has already been paid on that money. If you expect your current tax rate to be higher than the tax rate when you withdraw the money, choose the RRSP account. By deferring the taxes you’d pay on your contribution, you can take advantage of paying less tax at a later date.
A lot could change with a potential election coming up, but hopefully the TFSA sticks around for good. Any incentive to save is a good thing (unlike a GST cut, which promotes consumption). Contribute using money saved by choosing a smaller coffee, skipping a shopping trip, and holding off on an iPod that’s bound to be be outdated by tomorrow anyhow.
One more thing: if, instead of buying a now-archaic 1st-gen iPod, you had thrown $400 into Apple stock, you would have had about 45 shares—worth almost $9,000 at the end of 2007. If the shares were in a TSFA account, none of the $8,600 capital gain would be taxed and that's some green, grasshopper.
Photo by OhioProgressive.
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The TFSA is an absolutely brilliant idea.
This completely rocks.
Good piece. Questions: what is the money invested in? Is it just a money market account like a GIC or can it be used to purchase investments? Value increases markedly if the latter.
Re: "A lot could change with a potential election coming up, but hopefully the TFSA sticks around for good. Any incentive to save is a good thing (unlike a GST cut, which promotes consumption). Contribute using money saved by choosing a smaller coffee, skipping a shopping trip, and holding off on an iPod that’s bound to be be outdated by tomorrow anyhow."
Saving doesn't decrease consumption. The error is in thinking of stacking cash in an account to be equivalent to hiding under a bed. In reality, whatever is saved will be lent out and/or consumed by others. Likewise, a GST cut would only promote consumption equal to its demand stimulus, i.e., the amount people are willing to spend because prices are infinitesimally lower (negligible on the whole). In reality all it does is reduce the governments take from consumption of goods and services in the economy. There are many reasons to dislike the GST cuts, but this isn't really a good one.
One thing that most analyses of the TFSP and RRSP forget is that a $5000 RRSP contribution reduces your tax payable by $750. I suppose you could take that $750 and put into the TFSP.
I still say the government could have eliminated taxes on investment income all together. That would have eliminated the need for RRSPs, RESPs and TFSPs. Alternatively, if the lefties get all up in arms about 'something benefiting' the rich, the Government could have introduced some fixed annual investment income exemption (say $500 or $1000). Whatever you don't use you could carry forward.
There plenty of ways the government could have achieved the same result as a TFSP without having to create yet another group of savings accounts.
@x_x:
You can invest in a TFSA as you would a RRSP, including investments. For people hurting from rising gas prices, a few shares in Suncor or Encana would offset the increased costs.
Re: "Saving doesn't decrease consumption. The error is in thinking of stacking cash in an account to be equivalent to hiding under a bed. In reality, whatever is saved will be lent out and/or consumed by others."
Yes, you're right. (For more on this, check out The Rebel Sell.) I'm using "consumption" colloquially as short-hand for living beyond one's means and spending on superfluous purchases.
Regarding the GST: I would have preferred an income tax reduction instead, which doesn't only reward those who buy, buy, buy.
@Vincent Clement:
Re: "One thing that most analyses of the TFSP and RRSP forget is that a $5000 RRSP contribution reduces your tax payable by $750. I suppose you could take that $750 and put into the TFSP."
I think I see where you're going with this. However, you can't count the $750 you get back as part of the equation. Remember: most people pay for RRSPs with their post-tax money. The $750 is not additional income, but just the government returning what it has pre-taxed.
Great article. I recently started an RRSP, I'll have to look into the TFSP too.
The government suggests that Canadians in the two lowest tax brackets would soak up over three-quarters of TFSA benefits
This is of course by virtue of simple numbers, rather than by its effectiveness as a tax hedge for the lower classes. There are a lot more people in the two lowest tax brackets then there are in the top two - remember, the median household income in Canada falls about midway through the second tax bracket. (The median individual income in Canada varies from year to year but generally falls right around the dividing point between the lowest tax bracket and the second lowest.)
Given that the impact of a TSFA is class-neutral (IE, no matter how rich you are, you can only put in five grand a year tops), and that the bottom two brackets comprise about ninety percent of the population, it shouldn't come as a surprise that TSFA benefits "would be soaked up" in the proportions they claim. Of course, the fact that ninety percent of the population soak up a less than proportional amount of the benefits of TSFAs, even in the wildest-dreams scheme the Tories have been advertising, should put the lie to the concept that this is a tax scheme that predominantly benefits the lower classes.
The simple truth about TSFAs is that they're very good for median to high income people, and for low income people in rural areas, where cost of living is lower. If you've just noted a certain conflation with Tory voting demographics, give yourself a cookie and pretend to act surprised.
Great piece. I was always jealous of the Roth IRAs in the States, and I'm so glad that we'll have our own TFSA.
The simple truth about TSFAs is that they're very good for median to high income people, and for low income people in rural areas, where cost of living is lower. If you've just noted a certain conflation with Tory voting demographics, give yourself a cookie and pretend to act surprised.
What explains the efforts of all the other parties to extend tax breaks to contributions to RESPs (still to go to the Senate)?
"The simple truth about TSFAs is that they're very good for median to high income people, and for low income people in rural areas, where cost of living is lower. If you've just noted a certain conflation with Tory voting demographics, give yourself a cookie and pretend to act surprised."
Any tax sheltered investment account benefits people who have disposable income. A "simple truth" indeed. Though I would have thought it would be hard to attribute nefarious intentions to the policy design, as a result.
Also, your comment about the rural population is a bit dim - cost of living is lower in rural areas, but overwhelmingly so are incomes. You really need to be looking at after tax incomes/cost of living if you are going to class this as a sop to the gun-owning, tractor-driving, tory-voting non-urbanites you hold in such contempt.
Further, I don't share your assumption that below-median income Canadians lack disposible income to take advantage of the shelter (not a "hedge", as you incorrectly termed it) for a number of reasons, among them: (1) you are not looking at after tax income, which the lower quintiles retain more of due to high basic personal exemptions; (2) you are looking at raw income numbers which don't take into account cost of living; lets pretend Canada is larger than Toronto: a median income wage gets you further outside of Toronto than within; (3) two median incomes in the same household > one above-median income and one caregiver, due to inability to income split, etc.. All of which is to say, as is said every year and even by StatsCan itself when the charity sector perverts its low-income cut-offs for their own causes, income alone is a poor indicator of poverty.
More directly, those with less can benefit greatly from tax-exempt saving vehicles that do not penalize withdrawals, as a means of generating capital which can be applied, say, to a downpayment on real property, or to education, or to any number of things that increase social mobility. Or would you prefer if below-median earners remained poor?
More broadly, by increasing the savings/investment rate s tax shelter increase the rate of investment, which spurs economic growth, which drives increases in living standards. All horrible things.
One thing I haven't seen discussed in any detail is how much the financial institutions will charge for these accounts. No doubt more to come.
A further comment; an RRSP is not of great benefit to younger people whose income is not high as the tax saving is not significant. Putting money in a TFSA for some years and then when their income is higher and they have accumulated some RRSP room, moving the savings from the TFSA to an RRSP could be sensible.
I assume the TFSA will be similar in pricing as RRSP accounts.
For younger people, it's definitely worth it to learn how the TFSA works. Assume a university student works part-time and earns $8,000 a year. That's below the Ontario and Federal basic personal amounts, ie. tax-free. The 18% RRSP contribution limit of $1,440 is better off rolled over.
After four years, the student now has over $5,600 of contribution limit. With a better paying job, the limit could be worth at least a grand or so in tax savings.
If this scenario starts next year, the student could save the $5,600 in a TFSA, accrue interest, and score a couple of hundred bucks as well.