New Tax Free Savings Accounts will jumpstart Canadian savings rate after years
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
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."