Ten years on, the TFSA’s success could lead to its demise

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Born of the ashes of the worst market meltdown since the Great Depression, the tax-free savings account enters its 10th year with an uncertain future.

When the TFSA was launched in 2009, the value of equities had been slashed in half in less than three months. To help provide an incentive to invest in the capital markets, then-Finance Minister Jim Flaherty introduced a registered trading account where investment gains were free from taxation and withdrawals could be made at any time. (In a non-registered trading account, half of equity gains are subject to taxation, and income generated from the investments is fully taxed.)

From that 2009 market low, stock markets have more than tripled. By 2016, nearly 17 million Canadians had opened TFSAs with $194-billion in assets, according to the Canada Revenue Agency.

"It's a great vehicle for people to save and invest for their future," says Mark Grammer, managing director and portfolio manager at Toronto-based Gluskin Sheff + Associates Inc.

Mr. Grammer considers the TFSA an ideal complement to the traditional registered retirement savings plan (RRSP). Unlike with a TFSA, RRSP contributions can be deducted from income but investments and any gains they generate over the years are fully taxed when they are withdrawn.

Tax savings in a TFSA add up over time, he says. "It's tax free. If you can compound it at 10 per cent per annum, at retirement it's a significant amount of money you don't have to pay tax on when you withdraw," he says.

Mr. Grammer sees TFSAs as a good alternative for lower-income Canadians and millennials, who usually don't save as much on taxes through RRSP contributions because they are in lower tax brackets. He says the most tax efficient investment to hold in a TFSA is a diversified portfolio of equities, which can be risky but tends to produce the highest returns.

"My advice – especially to younger people – is to put their riskier investments in the TFSA. If your time horizon is long enough and you have a high risk tolerance, in theory your returns should be higher. You can afford to take that risk for the long term," he says.

For 2018, the TFSA contribution limit is $5,500. That brings the total contribution limit since its inception to $57,500 for anyone who was 18 years or older in 2009. For anyone who turned 18 since, contribution space accumulates from that year forward. When withdrawals are made, the contribution space is restored in the next calendar year.

The original annual contribution limit in 2009 was $5,000. An inflation adjustment brought it to $5,500 in 2013 and 2014. In 2015 the Conservative government raised it to $10,000, but the incoming Liberals scaled it back to $5,500 in 2016, where it has remained.

For 90 per cent of TFSA holders, however, contribution limits are a non-issue. According to the CRA, only 10 per cent of TFSA holders contributed the maximum amount as of 2015. That's hasn't stopped calls from the Conservative opposition and investment industry for higher contribution limits.

Even at $5,500 a year, Ottawa has already forfeited countless dollars in tax revenue and committed itself to surrendering further countless dollars as the number of Canadians with TFSAs – and the amounts invested – increases.

"The TFSA is a long-term drain on government resources as opposed to an immediate one," says Myron Knodel, manager of tax and estate planning at Investors Group in Winnipeg.

Mr. Knodel questions the sustainability of the TFSA as an all-out "tax free" investment account as the federal government searches for new sources of revenue. He doesn't rule out lower contribution limits – or even a freeze – in future years.

"I could see that. A moratorium for a couple years," he says.

Another measure that would make the TFSA less burdensome on government accounts could be the imposition of individual lifetime contribution limits.

"They could say, 'Whatever room you have now, you can keep that, but we're not going to add to that each year because the amounts in there are getting too big,'" Mr. Knodel says.

With governments looking for ways to provide for an aging population, Mr. Knodel also doesn't rule out new methods to sweep money from the shelter of TFSAs into taxable income. As an example, he suggests entitlements for Old Age Security could be clawed back if Ottawa decides to designate money from a TFSA as income for retirees.

"It could be done, but it would introduce a fair amount of complexity and would be directly going against the promises that were made in the past," he says.

"It would be very unpopular, but a lot of tax changes are unpopular and they still seem to be getting away with it."