Tax Free Savings Accounts Revisited

Outside the Box, she thinksThe day after I posted a few skeptical thoughts about the new $10,000 TFSA limits in Canada, a Financial Post writer made the argument that TFSAs could “help a middle-class couple save $1.1 million”.  That’s a lot of dough.  To get to it Ted Rechtshaffen imagined two 40-year-olds each earning $80,000 a year.  They have two kids and a $750,000 house with a $300,000 mortgage.  They spend $100,000 each year, after tax.  They already have $150,000 each in RRSPs.  They already have $43,000 each in their TFSAs.  And they already have $25,000 total in regular savings accounts.

First of all, if that’s you, congratulations!  Seriously, at the youthful age of 40 years-old, you and your better half are living in an expensive home and together you enjoy spending $100,000 every year, after taxes.  And you already have tens of thousands in RRSPS, TFSAs and regular savings.  And you have no debt!  Holy Murphy!  I didn’t even mention yet that you and your better half plan on retiring at 58, according to Rechtshaffen’s hypothetical.  I did not know that the “middle-class” tended to retire before  60, but now I do.  I definitely should have spent less money on beer when I was in school.

In any case Rechtshaffen gets to the good part — the “$1.1 million in savings” part — by contrasting an RRSP route with the new $10,000 TFSA route.  Here Rechshaffen tucks in the assumption of a “6 per cent annual growth rate on investments”.   This is precisely the assumption that deserves scrutiny because a 6 per cent annual rate on an “investment” carries genuine risk.  Depending upon how the economy unfolds, a 6 per cent “investment”  might well result in a loss.  If it does, then it will quickly become apparent that the TFSA was a “Savings Account” only in name.  And the loss might not only be in interest, but in the principal as well.  The point in my previous blog was simply that TFSAs are only beneficial to risk-taking account holders (“investors”), not risk-averse savers, assuming the economy does not tank unexpectedly.  Rechshaffen’s piece is consistent with this view.  Rechtshaffen rosily imagines young “middle class” small-c capitalists investing their way into early retirement without any kind of 2008 Great Recession diverting their course.  (Jamie Sturgeon recently quoted BMO chief economist Doug Porter as noting, “High income earners” in Canada “would be holding the lion’s share” of an increase in assets held by Canadians nationally.   Sturgeon added, however, that “at least 12 percent of Canadian households…are extremely indebted, another record high,” or so Bank of Canada numbers would suggest).

Ultimately Rechtshaffen finds the $1.1 million savings largely in the fact that a 79-year-old widow will not get saddled with taxes from her recently deceased husband’s Registered Retirement Income Fund (RRIF) if the couple had chosen the TSFA route over the RRSP route when they were 40-years-old.   Over the next ten years of her life the widow will also avoid other taxes that RRSPs would produce.  In her coffin at 89 years of age she finally leaves her quietly-excited kids with a lot of dough: a $4 million dollar house and a TFSA worth over $1.1 million “that has no tax issues.”  Yowza!  That’s the “middle” class for you.  And you thought it needed to be saved?

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