Still More on Tax Free Savings
I’ve posted below some interesting comments from Richard Shillington, a senior associate at Informetrica Ltd – who among many other accomplishments has drawn attention to very high effective tax rates on low income Canadians, and the failure of many programs to reflect the realities of life in low income.Â I think Richard advances a good alternative solution to a real problem addressed by tax free savings accounts.
“As some of you know I’ve been pushing for some form of relief for the millions of Canadians who retire without an occupational pension and end up with a median income of about $15,000.Â If this weren’t bad enough the design of GIS makes it near impossible for them to improve on this by earnings or by RRSP withdrawal – even their CPP was subject to aÂ 50% on top of which the income is still taxable (many won’t pay income tax but some will). Put this person in social housing where their rent is 30% of income and their “Effective Marginal Tax Rate” is now 100%.
About half of Canadians retire with no occupational pension. The majority of those who retire without an occupational pension are eligible for GIS. About 80% of RRSP assets are held by those with an occupational pension.
I recall that about half of those who retire with no occupational pension have some RRSP – the average amount is $30,000-$40,000.Â Given their modest incomes many people sacrificed in order to accumulate this small RRSP.
Many low and modest income CanadiansÂ do they just don’t save much.Â Yet the GIS rules ensure that any RRSP them virtually no good.Â Indeed, because of GIS clawback, CPP for manyÂ lower-income CanadiansÂ is not such a hot investment; it becomes a mutual fund with a 50% back-end load.
My preferred option is to expand the GIS earnings exclusion to other forms of income. GIS should ignore about $4,000-$5,000 of earnings but also other income – like CPP and RRSP withdrawals.Â This allows all Canadians to save in an RRSP without them having to guess whether they are “GIS destined” or not. Lower-income Canadians will not save much and will know that, at retirement, if they just keep their RRSP withdrawals belowÂ some modest amount ($3,500) it will not affect their GIS. This would also make CPP a much better deal for them.
The $3,500Â earnings exemptionÂ in the budget is a great step but doesn’t go far enough to be remedy because it is only for earnings. This remedy would have been much cheaperÂ to the government than this TFSA.
This TFSA with theÂ annual $5,000Â of room helps my “futile savers” but has it’s problems. First, Canadians without an occupational pension will still have to decide if they should use an RRSP or TFSA. The banks and insititutions don’t sell good advice, they sell mutual funds. The TFSA’s don’tÂ simplify retirement planning for those without a pension plan.Â We will need to develop financial advice tools for lower-income Canadians to help them navigate the RRSP/TFSA decision.
I also think that, in the long run, the TFSAs are HUGE for a few very high income Canadians.Â The accumulating $5,000 annual contribution limitsÂ are indexed (albeit awkwardly).Â At 48 you have a limit,Â in constant dollars, of $150,000 per person inÂ a couple.
So I would modify the TFSAÂ Â to limit the life-time contributions toÂ a more modest amount, say $50,000. This will help my futile savers while limiting the wind-fall to the wealthy.
Remember, that in the short term these TFSA’s are not a windfall for the wealthy and will help many low and modest income Canadians. The unaccpetable windfall only happens over the long-term. We have 10 years during which one could create a life-time limit which is acceptable.Â
Bottom Line…Â Â
The TFSA is a remedy for my ‘futile savers’ but not my first choice.
As proposed, it’s better than the status quo (some will disagree we’re weighting trade-offs). But in the long run, it is very generous toÂ a few higher income Canadians but we can fix that later.
So… one could advocate for a broader GIS exemption instead (good luck on this,Â this TFSA is out of the bag and will be popular. I would suggestÂ advocating forÂ limitsÂ to the ‘open ended nature’ of theÂ TFS, keeping itsÂ value for modest and lower income Canadians – many of whom do save in small amounts, but impose a life-time limit – say $50,000.
This would also be a great opportunity to advocate for a $5,000 reduction in RRSP limits.