News Update

New Tax Free Savings Accounts will jumpstart Canadian savings rate after years of decline

Most dramatic change in Canada's savings system since the RRSP will result in an additional $115 billion to be "socked away" by 2013, says CIBC World Markets report - Socking money away is becoming a bigger priority for Canadians, and that trend will likely lead to a huge uptake in the new Tax Free Savings Account (TFSA) plan which will be introduced to Canadians in January 2009, notes a new CIBC World Markets report.

"The TFSA will kick in exactly when many Canadians are making the transition from passive savers to active savers," says Benjamin Tal, Senior Economist at CIBC World Markets in his Consumer Watch Canada Report. He expects the TFSA market to mushroom to $115 billion by 2013 with cumulative tax savings of close to $2 billion.

Mr. Tal says changes in the economy are driving Canadians to rethink their savings habits for the first time in 20 years. He notes that an extended period of low interest rates, modest inflation, slow income growth and soaring home prices over the last two decades made Canadians feel less pressured to save. These factors contributed to a dramatic drop in the savings rate, and greater reliance on increases in home equity to offset the savings shortfall.

"But now, the levelling off in house prices is stripping households of one of their most important means of savings," says Mr. Tal. "And just when Canadians are ready to go back to old fashioned savings behaviour, the introduction of the TFSA will provide them with an additional tool to raise their active savings." He notes that the TFSA plan is "arguably the most dramatic change in Canada's savings system since the introduction of the Registered Retirement Savings Account (RRSP)" and that it should be viewed as a "companion to the RRSP" not a rival. "The magic behind the TFSA is in its versatility. It is not simply a tax measure designed to help low-income Canadians, but rather a vehicle that can fit almost every Canadian, regardless of income or stage of life."

As a result, Mr. Tal expects about 400,000 low-income Canadians that currently contribute to an RRSP will switch to TFSA. That translates into $2.5 billion in cumulative contributions from this group over the next five years. "The current system discourages low-income Canadians from contributing to RRSP since their withdrawals after retirement might reduce the eligible tax credit and supplementary pension payments. In contrast, the TFSA is truly tax exempt-free of any clawbacks from federal tax credit and benefit programs," says Mr. Tal.

For seniors, the "TFSA is an attractive channel to save beyond the current cut-off age of 71 for making RRSP contributions," says Mr. Tal. He adds that TFSA account assets can be transferred to a surviving spouse or child, tax-free without affecting the beneficiaries' contribution rooms. The TFSA also benefits high earners who've reached their RRSP contribution limit, and want to build additional savings tax free. For the nearly 40 per cent of paid workers that are covered by a registered pension plan, the TFSA can also help compensate for the pension adjustment that limits RRSP contributions.

Mr. Tal notes that another key feature of the TFSA is its flexibility makes it ideal for immediate needs such as emergency funds as well as a tax efficient way for Canadians to finance consumption. "The account can be accessed multiple times during one's lifetime to serve as emergency funds, and to bridge periods of income volatility. This liquidity feature of the TFSA plan is of great importance as it will probably work to limit or even eliminate uneconomical behaviour such as RRSP withdrawal. In fact, the liquidity feature is viewed by Canadians to be as important as the tax-free feature in the decision to open a TFSA." To assess the potential popularity of TFSA, Mr. Tal reviewed the U.K.'s experience with a similar plan, and the results of a recent Harris/Decima survey measuring Canadians intentions to use these accounts.

Based on the findings, he expects more than 40 per cent of Canadians are likely to use new money in contributing to the TFSA. This means the plan itself will increase the savings rate among Canadians, and not siphon away existing contributions from RRSPs. He believes that a significant portion of the money parked in TFSAs will be in cash and cash equivalent accounts, an assumption supported by the Harris/Decima survey. He also believes that TFSA usage by age and income level will be similar to Britain. There, half of high income individuals contribute to an equivalent plan compared to 30 per cent with lower incomes. Also, people 55 and older contribute more than other age groups.

Since the launch of the plan in Britain in 1999, the number of accounts has risen at an average rate of six per cent a year. And with the British adult population hardly changed over the past decade, the share of U.K. citizens that use the plan rose to 37 per cent in 2008 from 22 per cent in 2000, notes Mr. Tal.

In 2009, the first year of the program, Mr. Tal estimates that Canadians will contribute $20 billion to TFSAs, and like the British, "continue to use the vehicle at an impressive rate."