Tag Archives: TFSA

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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Are Canadians being encouraged to save or to spend?

StimulusPackage 001 (2)Yet again the spring delivery of the federal budget has proven to be a terribly exciting moment for Canadians.  Granted, it cannot distract from the nightly widescreen on-ice flourishes of the Habs, the Sens, the Jets, the Flames and the Cannots (no, not the Leafs — the other blue team, near all the saltwater), but it tries.  The media bees have swarmed around Joe Oliver’s throwaway comment about future budgetary problems being left to the Prime Minister’s granddaughter to solve.  But this little twister does bring us to the modest query of this post. Canadians now get to put $10,000 into tax free savings accounts (TFSAs) every year, $4,500 more than past annual entitlements.  What a terribly generous development, or is it?  The hope is that Canadians will be encouraged by the tax-free status of these accounts to put money into savings accounts rather than to spend money irresponsibly on $4.00 lattes or $2.00 Timmies, Cannots seasons tickets, and other such non-durables.  However, anyone who has walked into a bank or credit union lately has probably noticed that the average interest rate they will get for a $5,000 or $10,000 deposit is about 1%.  Some banks actually call their 1% offering a “high interest” rate.   Like gymnasts, words can be so flexible.  A rudimentary calculation suggests that, at the amazing high rate of 1% interest, a $10,000 TFSA will produce $100 annually.  This is about $8.33 per month, probably as much as some customers’ monthly banking administration fees, but let’s not get sidetracked.   The bank customer who gave the bank $10,000 now gets the great pleasure of not having to pay tax on a mere $100 annually.  In real terms, this benefit to the customer is virtually nil.   However, the benefit to the bank is huge because it acquired a lot more money to invest than it would have obtained otherwise, and at only a tiny cost to itself (1%). So, the wily Canadian thinks, I’m gonna beat this system:  I’m gonna put my $5,000 or $10,000 into a higher risk TFSA.  That way, if the stock-market does not throw any major curve balls in the next few years, I’ll reap greater investment rewards, all tax free!  Or better yet, because the lending rate is also below 1%, the wily Canadian thinks just like the wily American did in the early 2000s: now is the perfect time to buy a house, preferably one of those modest $1 million specials in Vancouver.  After all, the market is going crazy there.   One’s equity will double in no time flat. (Or, as it did in America in 2008, it might nosedive). Now the question returns.  Are Canadians being encouraged to save or to spend?  Persistently low lending rates and savings account interest rates strongly suggest that the federal government is encouraging Canadians to spend, and not even carefully so.   (See Jamie Sturgeon’s observation from March 18, 2015, that “[m]any Canadians have taken advantage of the unprecedented window of low-interest debt over the past decade, tilting the oft-cited debt-to-income ratio…to 163 per cent, a record high.”)  This tacit reality is premised on a long-standing economic belief that a fragile economy desperately needs investment from everyone, capitalists and average consumers alike.  The wisdom of this belief can be tested later, but for now the Canadian with very little savings to put in a bank account, whether it be a TFSA or a regular account, obtains virtually no financial benefit by doing so.  His or her bedroom mattress may be just as safe and ultimately less costly.

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