So anticipated that they are sparking pre-launches at many financial institutions, Ottawa’s new tax shelter, Tax Free Savings Accounts (TFSAs) is being hailed by the industry as the greatest revolution since the emergence of Registered Retirement Savings Plans in 1957. Yet surveys reveal that many Canadians are ill informed about TFSAs.
Jan. 1, 2009 marks the launch of the TFSA. Canadians 18 years or older can contribute up to $5000 per year into their TFSA accounts.
These accounts could represent a $20 billion market as of 2009 forecasts a study conducted for CIBC Capital Markets by Benjamin Tal, published in September. Within five years, assets held in these accounts may reach $115 billion, yielding potential income tax savings of about $2 billion for individuals, says the study.
The United Kingdom blazed the trail in 1999, with the launch of the Individual Savings Account (ISA), a tax shelter similar to the Canadian TFSA. The number of ISA accounts has grown by an average of 6% per year. One year after its inception, 22% of adults had acquired an ISA.
Here in Canada, the TFSA is also poised for a spectacular debut. Although the account has yet to take effect, several financial institutions are heralding the imminent arrival of the TFSA in their product line. Some offer preregistration of existing and potential customers. The institution then creates the account before yearend so it can quickly make it accessible early in 2009.
"It's just smart for Canadians to invest in TFSAs in order to save on tax," says Peter Aceto, CEO of ING Direct. On Oct. 30, the bank announced that it had enrolled 100,000 Canadians for Tax Free Savings Accounts in less than one month. ING is making an offer enticing: double the interest rate - which amounts to about 6% on amounts deposited in a transitional account until Dec. 31. The assets will then be transferred to a TFSA.
Since June, Sun Life Financial has offered guaranteed investment certificates at higher rates to lock in assets before automatically transferring them to the TFSA on Jan. 1. Kevin Strain, senior vice-president individual insurance and investments explains that this approach will ease administrative procedures considerably once the TFSA is officially launched.
Desjardins Financial Security (DSF) introduced the DFS Transition account, which gives customers an advantageous interest rate on deposits pending the opening of the TFSA. Claude Paré, senior director of product development and marketing, individual savings, says that the DFS Transition account offers advisors a chance to meet their clients before the official launching of the TFSA and to inform them of the advantages of this account in terms of tax planning.
The race to woo future contributors signals expectations of massive deposits into these accounts. Experts consulted by The Insurance Journal agree that all the conditions are in place to make TFSAs attractive for the retail market. Even without new money to contribute, individuals can transfer their non-registered assets into a TFSA, where they can grow fax free.
Gordon Gibson, senior vice-president and managing director, retail services at National Bank Financial, gives two reasons for financial institutions' eagerness to open TFSAs in their systems, even before they are accessible to the public in 2009. Naturally, the institutions want to capture the largest possible market share. The second motivator is the desire to lighten the administrative burden of opening a multitude of new accounts come January.
Despite industry optimism, the public's lack of knowledge about the shelter may hamper its success, at least at first. A recent Harris/Decima survey finds that only 3% of respondents have an in-depth knowledge of TFSAs, 45% have a vague idea about these accounts and 40% have never heard of them.
Kevin Barber, vice-president product research at Fidelity Investments, points out that financial advisors play an important role in educating their clients. He says that a good starting point is to meet customers as soon as possible and talk about the tax benefits offered by the TFSA.
Mr. Strain, of Sun Life sees the TFSA as an important component of financial planning. "We want our advisors to be the first one to talk to their customers."
A recent survey by Investors Group shows that fewer than 46% of Canadians plan to open a TFSA. Lack of knowledge of the product is behind this reluctance: nearly half of the respondents claim to be uncertain about how the TFSA works or admit that they have never heard of this type of account.
During the financial planning process, advisors should determine, jointly with the clients, whether it is more advantageous to contribute to a TFSA, an RRSP or both. They should also review the assets held in non-registered accounts. "Transfers of money from non-registered accounts to a TFSA is a way to stop the income tax bill from accumulating," Mr. Barber explains.
Mr. Gibson, of NBF, thinks that everyone can benefit from the new tax tool, but adds that "you need money to contribute to a TFSA. We anticipate that most contributions will come from more affluent people."
Mr. Gibson gives the example of the ISA in the UK. Account holders tend to be well off. Slightly more than 50% of individuals that opened an ISA are situated in the highest income bracket, compared with about 35% for the lowest bracket, reveals data from HM Revenue & Customs (British tax agency) cited in the CIBC study.
TFSA or RRSP?
Tax experts consulted by The Insurance Journal explain that the two accounts play complementary roles in a financial plan. Frank Di Pietro, director tax and estate planning at Mackenzie Financial, says that "the TFSA is not designed to replace the RRSP. The degree to which you use one or the other will depend on your particular situation, but it is important that the two go hand in hand."
Mr. Gibson agrees: "People should not consider either account in isolation. The optimal tax strategies use TFSAs and RRSPs to maximize advantages for the individual," he says. That is why it is important for advisors to establish a solid tax plan with their clients.
When is the TFSA or the RRSP the best choice? Mr. Strain of Sun Life says that "the client first needs to establish a financial plan with the advisor and then see how the TFSA fits into that." In general, advisors must compare the individual's marginal tax rate at the time of the contribution to that which is anticipated during retirement. If the two rates are similar, as is often the case for the affluent, the TFSA and RRSP are interchangeable. All the same, wealthy people that contribute the maximum to the RRSP, namely $20,000, can now take advantage of a second tax shelter as they save for shorter term projects.
In contrast, the TFSA should appeal in particular to people such as students, recent graduates and young families that expect their annual income to rise in the coming years. Once they are earning higher salaries, they can start contributing to their RRSPs as well and benefit from tax deductions. If they wish, they could then withdraw the income accumulated in the TFSA and transfer it to the RRSP.
Mr. Di Pietro, of Mackenzie, gives the example of a recent graduate that joins the work force. Even if his salary is not very high, he may want to start saving for his first home or car. "The TFSA may make more sense because it gives more flexibility while saving taxes," he says, adding that "a young professional may delay contributing to an RRSP because the tax deduction will not provide significant tax savings."
Interestingly, the TFSA can correct an anomaly in the Canadian tax system. The RRSP is not the ideal retirement savings tool for Canadians with very low income. Sylvain Chartier, financial planning director at National Bank Financial Planning, cites the findings of the CD Howe Institute in 2001 (see inset text, page 6, Subsidizing the poor).
He explains that at retirement, low income earners are penalized when they withdraw from their RRSP or RRIF: each dollar of pension or investment income lops off 50 cents from the Guaranteed Income Supplement granted by the federal government. In contrast, withdrawals from a TFSA do not affect income-based government benefits. This could make the TFSA the preferred product for lower income individuals trying to save for retirement.
CIBC Capital Markets predicts that 400,000 low income Canadians who currently contribute to an RRSP might open TFSAs.
The TFSA could also appeal to certain seniors. At age 71, their savings options are often limited because they are obliged to convert their RRSP into a RRIF. They must then withdraw a minimum amount each year. Mr. Paré of DFS explains that people with excess income can deposit amounts in a TFSA. The assets could then continue to grow tax free, without eating into benefits.
TFSA in group insurance
Employees might also want to integrate a TFSA into their group pension plan. Hewitt & Associates counsels that "organizations that take a strategic approach to integrating the TFSA into their programs can differentiate themselves, demonstrate their innovation and commitment to employees, and re-engage employees in the company-sponsored financial security programs."
The human resources services firm surveyed close to 250 employers in June. It found that 43% of respondents would probably or certainly add TFSAs to their employee benefits programs. Another 45% were uncertain but would not rule out the possibility of eventually offering a TFSA.
DFS and Sun Life will give their employer clients the option of adding a group TFSA to their product line.
Éric Filion, senior director of product development and marketing, group retirement savings at DFS, confirms that "employers' reaction is very positive. Many of them should add the TFSA in the coming months. Enhancing employee benefits is a good strategy for attracting and retaining the best employees. It's a way to stand out from the competition."
Mr. Filion adds that the interest has been keenest in groups made up of high earners. "These participants' RRSPs are often maxed out," he points out. The TFSA then offers additional room for assets to grow tax free.
"If introduced and communicated effectively, a TFSA can provide a real benefit to employees and possibly a competitive advantage for employers," said Mazen Shakeel, senior retirement consultant with Hewitt.