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I like to reserve this column for talking about things that others in the financial press tend not to cover. The benefits of diversification, building portfolios using mutual funds, the off-the-shelf products: these are topics that are already well and extensively served by others, and I don’t need to put my two cents in. I’d rather talk about options trading, creating your own products to save on fees, or the risk side of the equation, and other matters that don’t get enough play.
Today, though, I do want to weigh in on something that has received a lot of coverage: the new tax-free savings account (TFSA) that was introduced in the federal budget last week. By all accounts except mine, this new account is going to be the best thing since sliced bread.
Granted, it’s better than what happened to income trusts. It’s better than the idea of charging no capital gains tax on funds reinvested within six months, mostly because the latter remains just an idea. But “the most significant, positive innovation in Canada's tax treatment of savings since Registered Retirement Savings Plans in 1957,” as one commentator put it? Please. Allow me to add a granule or two of salt to the hype.
I’ll dispense with all the positives — that unused contribution room can be carried forward; that almost all the same investments that qualify for an RRSP also qualify for the TFSA; that withdrawn money adds equally to the contribution limit of a subsequent year — these have been widely reported. So what about the not-so-good aspects of the TFSA?
Let’s start with the limit you can put into one, which is $5,000 per year. That’s not nothing, but it’s not very much either. Consider this: right now you can expect to make about $200 per year max on $5,000 invested in a good-quality corporate bond at par. That will give you a tax savings of what, $100 at most? In other words, this is no RRSP.
Consider also that the banks and other providers of TFSAs are likely to charge RRSP-level administration fees for these accounts, which could take away half or more of the $200 that you do make on your $5,000. This will, of course, get proportionately better when you have $10,000 or $15,000 in the account, but that will take years, literally.
Another concern I have is just who is going to be able to provide these TFSAs. The budget itself said that banks, trust companies, life insurance companies and credit unions could offer them. But if you’re like me, most of your money is at an investment dealer, not a bank or a life company. Further, I’m already paying two RRSP admin fees per year at my brokerage firm (one for a locked-in RRSP; one for a regular RRSP). If there’s any chance of getting a ‘quantity discount’ or getting my TFSA fee waived altogether, it will be at the brokerage firm where I’m already paying two fees. So why were mutual fund companies and investment dealers not mentioned in the budget? Have they been specifically excluded from offering TFSAs?
I could go on, say about there being a tax exemption only on the income and gains earned, not a tax deduction for the full principal amount as it is with an RRSP. Or about how a person could very easily be at a lower tax rate when they put money into a TFSA than when they take it out. But I won’t, at least not today.
Don’t get me wrong. I plan to establish a TFSA for myself as soon as 2009 rolls around, just to start accumulating contribution room. I may not put any money in it, and will try to get the fee waived therefore, but I will establish one. In the interim, I’d rather put the money into my RRSP first, and only then into a TFSA if it makes sense. Then in the third or fourth year, I’ll be able to deposit up to $15,000 or $20,000 into the TFSA, and won’t mind paying the fee so much, if there is one, at that point.
A TFSA is a decent product. But when you cut through all the hype, it’s not that great.
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