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Normandin Beaudry

A TFSA at Any Cost?


There, in black and white

NB Bulletin Vol. 12 N. 1, January 2009

Features of the TFSA

Starting in 2009, the TFSA allows taxpayers aged 18 and older to contribute up to $5,000 every year and earn investment income tax-free. This annual contribution limit will be indexed each year to the consumer price index (CPI) and rounded to the nearest $500. Excess contributions to a TFSA are subject to a penalty of 1% per month.

As is the case with registered retirement savings plans (RRSP), unused contribution room can be carried forward to the next year. In addition, investment income and capital gains will be free of tax. However, TFSA contributions and capital losses will not be tax-deductible. Moreover, amounts withdrawn from a TFSA will not be taxable and funds can be withdrawn at any time. Funds withdrawn can be paid back to the TFSA from the year following the withdrawal without affecting the investor's contribution room.

It is important to note that withdrawals made by investors will have no impact on government benefits. If, however, an employer opts to make contributions to a TFSA on behalf of its members, these contributions will be considered taxable income. Finally, it is important to know that, in the event of death, the value of the TFSA account at the time of death can be transferred tax-free.

Considerations associated with the introduction of a group TFSA

Examining whether or not a TFSA is appropriate when offered as part of a retirement program is always a good idea. Through this analysis, we realize that several key aspects can limit the introduction of a group TFSA.

Who will benefit from the addition of a TFSA?

From a retirement investment perspective, few members have a profile that could currently allow them to make optimum use of a TFSA. Tax analyses have in fact shown that it is preferable to favour contributing to an RRSP as opposed to a TFSA, when the expected tax rate at retirement is lower than the tax rate applicable during the employment period, which should be the case for the majority of members. Workers whose salary is under $20 000 could, however, take great advantage of the TFSA because, unlike RRSP withdrawals, TFSA withdrawals do not reduce the Guaranteed Income Supplement (GIS). These workers are not, however, the most likely to have considerable funds to put towards savings.

Similarly, given that TFSA withdrawals, unlike RRSP withdrawals, do not reduce the Old Age Security (OAS) Pension, the TFSA could also allow highly paid individuals (workers whose salary exceeds $100 000) to maximize their retirement income. The TFSA also constitutes a second tax-free investment vehicle for these same highly paid individuals who have no remaining RRSP contribution room. The same reasoning applies for workers who have a generous defined benefit pension plan whose pension adjustment (PA) greatly reduces their RRSP contribution room.

For investors who will use the TFSA on a shorter term basis, the tax savings from the TFSA may not be sufficient to cover the fees incurred when they withdraw funds. Similar to workers nearing retirement, individuals with a short-term investment horizon should invest more conservatively. Because more conservative investments generate more modest returns and because administration and withdrawal fees may represent approximately 1% of the amount invested, an investment outside the TFSA is likely more suitable.

How could the addition of a TFSA impact a retirement program?

Before a TFSA is added to a retirement program, an analysis of the potential positive and negative repercussions of this addition must be conducted. A TFSA can alter the nature of the retirement program, and may even contradict the general objective of long-term savings. It may also reduce contributions made to other savings vehicles already in place because some members could view the TFSA as a substitute for the RRSP if the addition of the TFSA is not properly communicated. Moreover, the introduction of a TFSA may influence the primary investment decisions facing members, i.e. determining the contribution level and asset allocation. Because a great deal of progress remains to be made as regards assistance in making investment decisions, it is preferable to ensure that these decisions remain the focus of members' concerns.

Finally, the addition of the TFSA to a retirement program may increase the sponsor's fiduciary responsibility. The sponsor should provide members with tools designed to help them make investment decisions, such as tax optimization tools, to satisfy the Guidelines for Capital Accumulation Plans, to which the TFSA will likely be subject. At present, only a few Canadian service providers are able to offer group plan members customized tax optimization tools.

All in all, the decision as to whether or not to introduce a group TFSA must be made as part of an overall reflection exercise pertaining to the structure of the retirement program. It is thus imperative that sponsors examine their programs to identify the vehicles most likely to meet members' needs, which may include a registered pension plan, an RRSP, a TFSA or a non-registered plan such as a share purchase plan.


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