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Blog by Linda M Linfoot

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Economic Highlights


The 2008 federal budget gave birth to arguably the most dramatic change in Canada’s savings

system since the introduction of the Registered Retirement Savings Account (RRSP).

The Tax-Free Savings Account (TFSA) is simply a tax exempt savings account which is available to

any individual aged 18 and over. At this point, the maximum contribution is $5,000 a year—a

figure that will be indexed to inflation in multiples of $500. Unlike RRSPs, TFSA contributions are

not tax deductible, and the investment earnings are not subject to income tax. Any unused TFSA

contribution room can be carried forward, and amounts can be withdrawn at any time. So in

many ways, TFSAs are RRSPs in reverse.

How popular will the new scheme be? And to what extent will Canadians utilize the $120 billion annual

TFSA contribution room that will be available to them starting next year? Where will the money come

from? Will it be new money or will it be transferred from other accounts?

In this context, looking at the experience of similar plans in other countries might be a good starting

point. In the US, “Roth IRA” is a similar tax-free scheme, but it is much more restrictive than the TFSA since contributions are limited only to employed individuals and are restricted to only low- and midincome earners. It is also a pure retirement plan as individuals cannot withdraw the money before the age of 59. The British Individual Savings Account (ISA) is much closer to the TFSA—with the main difference being that the British plan imposes some restrictions on the cash/stock distribution held in ISA balances. In this sense, the Canadian TFSA is somewhat more flexible since it does not face such limitations.

But since the British version is so similar to the new Canadian one, it can provide us with some insightinto the future trajectory of the TFSA. Note that the ISA was introduced in 1999 and it is now a 270 billion market ($530 billion). The number of accounts has been rising at a strong average rate of 6% a year. And with the British adult population hardly changed over the past decade, the share of UK citizens that use the ISA has risen to 37% in 2008 from 22% in 2000. The average contribution is close to 2,500 ($4,800) out of the 7,200 maximum contribution allowed. Another useful source of information is a recent Harris/Decima* poll which examined Canadians’ knowledge, perception and intentions with regard to the TFSA. The results suggest that no less than 52% of Canadians aged 18 and over are planning to open a TFSA. This is not surprising given that 58% of Canadian households hold an RRSP account. Interestingly, almost one-fifth of those planning to open an account will use borrowed money. Furthermore, as opposed to what is assumed by many, more than 40% of Canadians are likely to use new money in contributing to the TFSA. This is consistent with the situation in the UK where more than half of the money invested in an ISA is new money. While the average contribution to TFSAs is reported to be just over $2,000 a year, 25% of contributors that maximize their RRSP or face a large pension adjustment will maximize their contributions. At the same time, 42% (most likely low-income and young Canadians) will contribute less than $1,000 annually. The issue of who will contribute is of great importance. While the budget assumption is that two-thirds of the tax savings in the next few years would be enjoyed by low-income Canadians, the experience in the UK suggests otherwise. No less than 50% of high-income individuals contribute to the ISA— significantly above the 30% seen among lower income UK citizens. As well, note that individuals over the age of 55 have the higher tendency to contribute to the ISA. There is no reason to believe that the age and income distribution in the Canadian TFSA scene will be fundamentally different than what we see in the UK. Based on this information we estimate that Canadians will contribute roughly $20 billion to the newly created TFSA in 2009, and will continue to utilize this vehicle at an impressive rate. Note that we assume a relatively modest 3-4% annual return on capital since the duality feature of the plan (investment for retirement as well as a vehicle to finance consumption) suggests that at least in the first few years, a significant portion of the money parked in TFSAs will be in cash and cash-equivalent accounts. This assumption is supported by the Harris/Decima survey. Accordingly, we project that by 2013, the TFSA market will grow to a $115 billion market**—with a cumulative tax savings for Canadians of roughly $2 billion.

* Harris/Decima poll taken between April 30 and May 5, 2008, sample size: 2,613.

**We assumed 2.5% inflation rate. We also allowed for a gradually rising withdrawal rate—reaching close to 10% by 2013.

Benjamin Tal

Senior Economist