TFSAs will lead to 'welfare' for the wealthy, government warned

[valve37]

Ottawa urged to close loopholes in tax-free saving accounts that will put billions in pockets of wealthy

The Conservative government is facing calls to change the rules around tax-free savings accounts now before a loophole means some of Canada's wealthiest people could start receiving "welfare for seniors."

TFSAs were created in 2009 and designed to encourage Canadians to save by – as the name suggests – putting such accounts out of the reach of the Canada Revenue Agency when it comes to taxing capital gains and other income such as dividends.

However, because the accounts operate outside the tax system, they are also ignored when it comes to income-tested government benefits such as Old Age Security (OAS), the Guaranteed Income Supplement (GIS), and even the allowance designed with the country's lowest income seniors in mind.

"The question is: what do we do?" asks Rhys Kesselman, who holds the Canada Research Chair in Public Finance at Simon Fraser University. "Do we continue to pay the GIS, which is intended for low-income seniors, to people who have large amounts in their TFSA?"

Kesselman estimates a person who starts squirrelling away significant amounts into their TFSA at an early age and invests it in a diversified portfolio can expect to have $750,000 to $1 million or more in that account by the time they reach retirement age – a sort of personal endowment fund that would continue to generate income tax free.

"If you're balanced between fixed income and equities, [you could get] six per cent, $60,000 a year — and that's tax-free," he said.

Taxable income includes any money received from pension funds — be it from the Canada Pension Plan, an employer's plan or a registered retirement savings plan.

Although some wealthier Canadians may find themselves with the enviable situation of drawing too much money from these sources, it is possible to suppress this income and thereby qualify for government assistance.

CPP allows for deferment until the age of 70 and RRSPs can be left untouched until the contributor turns 71, and the payoff for those who do so can be worth tens of thousands of dollars in government money.

"People are going to do it, not a lot of people, but people are absolutely going to [intentionally keep their income low]," says Finn Poschmann of the C.D. Howe Institute.

'Fairness perception'

Under current rules, couples in their 60s who keep their taxable income — which excludes TFSA money — below $32,000 a year, could be entitled to nearly $30,000 in government benefits including the allowance, a payment meant only for low-income couples.

"There will be a fairness perception problem," according to Poschmann.

'It's kind of negligent of governments to make a broad-sweeping, unrestrained promise that is bound not to be fulfilled.'- Rhys Kesselman, Canada Research Chair in Public Finance at Simon Fraser University

"I think just in terms of what taxpayers, voters think the GIS is for — they won't be too happy to see people with hundreds of thousands, or even a million or two million in a TFSA conceivably drawing the GIS," adds Kesselman.

Beyond the sense of fairness, there is also a looming fiscal cost.

In a recently released report, Canada's chief actuary estimates the OAS and GIS loophole will add about $4 billion to the government's annual net costs under the programs by 2050.

But those calculations were based on the current annual contribution limit of $5,500 – not the $10,000 limit expected to be announced in the 2015 budget to fulfil the last of the Conservative government's major election promises from the 2011 campaign.

A change of that nature will almost certainly amplify the projected cost to the treasury.

Changes needed

Both Poschmann and Kesselman believe changes to the rules are inevitable because of these factors.

"When it hits the fan in a big way, the public is going to react negatively and governments, I think, will respond," says Kesselman.

Poschmann cautions against scrapping TFSAs, pointing out what may seem an unfair loophole for the wealthy is one of the scheme's greatest assets for the poor: the fact it doesn't affect income-tested eligibility for other benefits.

"Part of the problem in our former system was the presence of income tests," Poschman explains, "it made it really dumb for low-income seniors to save in RRSPs because you have futile savings, you got dinged."

Income vs. asset tests

He suggests asset tests, rather than income tests, could be a means of addressing the issue.

The trick is to find a way of objectively cutting off or curtailing income benefits for the wealthy, while not punishing middle- or low-income earners who happen to be diligent savers.

Although the problem seems to be more than 30 years down the road, Kesselman urges the government to make changes quickly so the public knows what the rules will be from the outset.

"It's kind of negligent of governments to make a broad-sweeping, unrestrained promise that is bound not to be fulfilled," he says.

http://www.cbc.ca/m/touch/news/story/1.2843835

[pierrelebel]

"can expect to have $750,000 to $1 million or more in that account by the time they reach retirement age"

Whoever wrote that article is getting carried away with big numbers.

Back to Earth.

Assuming someone put away the maximum allowed in the last six years ($31,000) and earned 6% a year on average, that $31,000 would have grown to $38,061 at the end of this year.

Even if you add $10,000 a year for the next ten years, you get to $207,878 sixteen years after the beginning of the program.

That $207,878 would then earn, in year seventeen, $12,472 assuming the same 6% net return after tax.

Not bad.  Not bad at all but not the stuff that would really make a difference to the system when you seriously think about it.

Folks with real money (the so-called wealthy) have many other means to earn large amount in trust accounts, away from the taxman.

If a problem really exists, it will be at least ten years in the future to surface. Let's look at it then.

In the meantime, low and mid income earners can benefit from the program, so can fixed income seniors. 

There are many things to worry about in our government.  This possibility that someone accumulates one million dollars over the next thirty or forty years is very minor compared to the real problems faced by the administration.

[2014sportsterguy]

So what bank has 6% ? Your lucky to get 2 or 3.

[pierrelebel]

"So what bank has 6% ? "

We are not talking about banks.

No bank pays 6% on deposit.  That is not what TFSA or RRSP or other long term investment vehicles used for retirement planning are all about.

It is important to have a "reserve" in the bank earning 1% to 2% to cover emergencies that may come up from time to time.

Long term savings - using TRFA or RRSP or mutual funds - or other vehicles - on the other hand are "investments" not bank deposits.  It is quite reasonable to expect 6% return on the very long term.  Some investments will even do better over time if you ignore seasonal or annual fluctuations.

Many large Canadian public corporations will offer "preferred" shares.  Typically priced at $25 when issued, most will earn from 5% to 7% in "eligible" dividends (almost "tax free" if you earn no more than $40,000 a year).  Within registered accounts (TFSA or RRSP) many will hold REITs (real estate investment trusts) also typically paying a distribution of 5% to 7% annually. 

Looking at the long term, well diversified real estate is relatively very safe.  Residential (rental apartment buildings) generally pay a bit less (closer to 5%) since they carry little long term risks.  Commercial and industrial holdings pay a bit more (5% to 8%), depending on their diversification and tenants. If your shopping centre rents to WalMart, Canadian Tire, banks, etc... they carry little risk while those renting to local merchants may carry a higher risk and command a higher yield.

[pierrelebel]

Here is the current tax table for residents of Ontario:

http://www.taxtips.ca/taxrates/on.htm

Take a good look at the taxation of "eligible' dividends.  You can see how beneficial they can be when held directly (not through RRSP or TFSA where you lose the benefit of the dividend tax credit)