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Note to Flaherty: TFSAs are good but they can be so much better

There's still a little time to go in 2009, but the pick for the financial world's rookie of the year is already certain.

Introduced last Jan. 1, Canada's Tax-Free Savings Account is a complete success. Critics complained early on that the $5,000 annual contribution limit was too low to be meaningful, but today TFSAs are well established. All financial companies of note offer them, and a recent poll suggested that just about one in four Canadians has one of the savings vehicles introduced by Finance Minister Jim Flaherty.

So, what about improving the TFSA?

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"Holy smokes, what do you want?" joked Finn Poschmann, vice-president of research at the C.D. Howe Institute, a think tank that advocated for a tax-free savings vehicle.

"You've introduced a new kind of registered savings account and millions of people have opened one up in a few months' time. That's huge."

There are actually a lot of ideas out there for improving the TFSA, which allows people to save or invest $5,000 per year and pay no tax on their gains.

Suggestions from the financial industry focus largely on ways of allowing people to contribute more money to TFSAs, which is to be expected.

Banks and investment dealers had to invest a lot of money to update their systems to accommodate TFSAs, and they won't quickly recoup that money with a $5,000 cap on annual contributions. The cap is indexed to inflation, but in such a way that it will only be moved in increments of $500.

In other words, it will take a few years of inflation to get the limit up to $5,500 and beyond.

There are also arguments that it would be good policy to allow people to put more in TFSAs every year by, for example, doubling the current limit. "People are ready, willing and able to save more in [tax-sheltered]forms," Mr. Poschmann said.

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"There's no reason we shouldn't give them room to do that."

Five things you should know about TFSAs

  • You can contribute $5,000 per year from age 18 onward, and carry forward any unused room.
  • You get no tax deduction for making a contribution, as you do with an RRSP, but your savings or investment gains are not taxable.
  • By contributing even $2,500 to a TFSA every year, you could end up with almost $64,000 in 20 years at a modest average annual return of 2.5 per cent.
  • The range of eligible investments includes high-interest savings accounts, guaranteed investment certificates, mutual funds, stocks and bonds.
  • You need a self-directed TFSA from an investment dealer to have the fullest range of investment choices.

Other suggestions are aimed at helping people at or near retirement to get more value from TFSAs. The argument is that these people are at a disadvantage to younger Canadians because they will have less opportunity to use tax-free accounts over their lifetimes.

Malcolm Hamilton, a pension consultant with the firm Mercer, has raised the idea of retroactively providing 10 or 15 years' worth of contribution room to retirees or people nearing retirement.

A more generous approach would be to allow them to contribute as much as they would have been able to if they started at age 18, the minimum age for contributing to a TFSA.

"I'm sure there's a contingent out there that would say this is an outrage because it's only the rich that will be able to shelter the money and they should be paying tax," Mr. Hamilton said.

"The argument that goes the other way is that if you look at Canadians who have unsheltered money and are over 65, they're just dead in the water. They earn next to no interest, and whatever they do earn is heavily taxed. Their only hope for getting any kind of decent return is to get the money sheltered."

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The TFSA was introduced by a Conservative party that promised in the 2006 election campaign to eliminate taxes on capital gains that are reinvested within six months of being realized. That never happened.

But Carol Bezaire, vice-president of tax and estate planning at Mackenzie Financial, said the government could enhance TFSAs by allowing people to contribute stocks, bonds and mutual funds they already own to their accounts without triggering a taxable capital gain. Normally, in-kind transfers like these are considered to be the same as a sale, which means people must pay tax on any gains.

Two other suggestions from Ms. Bezaire are to reduce the minimum age at which you can have a TFSA and to allow for joint TFSA accounts. "This would allow grandma and grandpa to set up an account with a grandchild younger than 18," she said.

David Ablett, manager of advanced financial planning support at Investors Group, said one way to spur interest in the TFSA would be to allow a large one-time lump-sum contribution of, say, $25,000. He believes this would be a good incentive for seniors to contribute non-registered assets to their TFSAs and thereby generate tax-free income that would not put them at risk of a clawback of their Old Age Security benefits.

Whatever changes are ahead for the TFSA, Mercer's Mr. Hamilton has one request.

"I don't want them to become too complicated. One of the great virtues of the TFSA is its versatility and its simplicity."

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About the Author
Personal Finance Columnist

Rob Carrick has been writing about personal finance, business and economics for close to 20 years. He joined The Globe and Mail in late 1996 as an investment reporter and has been personal finance columnist since November 1998. Rob's personal finance columns appear in The Globe on Tuesday and Thursday, and his Portfolio Strategy column for investors appears on Saturday. More

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