This year marks the 10th tax-free savings accountvol anniversary. While the TFSA has provided Canadians with a powerful tax-free investment option, it has not been without growing problems. Like its older sibling, the RRSP, the TFSA experienced enormous changes during its first decade of existence.
The introduction of the TFSA in early 2009 created an excellent opportunity for tax-free investing. As markets bottomed out after the 2008 financial crisis, investors were poised for attractive returns. However, the contribution limit was only $5,000 per eligible Canadian resident.
Excessive contributions caused initial confusion and frustration. The penalty was quite clear: 1% per month for excess contributions. However, the confusion regarding contributions and withdrawals in the same calendar year may have been due to the fact that TFSA limits were originally reported in Canada Revenue Agency (CRA) assessment notices, which was a method rife with inaccuracies and quickly replaced by reporting via My CRA Account.
Common problems included re-contributions – withdrawing from a TFSA and re-contributing in the same year when the limit had already been maxed out – and entering into TFSAs with multiple financial institutions where total contributions exceeded the limit.
As of June 1, 2010, the CRA issued more than 72,000 notices of excessive premiums and tax penalties due for the 2009 tax year. The following year, almost 103,000 notices of possible overstatement of premiums were sent.
The agency waived penalties on a case-by-case basis, but it was a painful lesson for all parties.
Confusion aside, the 1%-per-month penalty didn’t stop some investors from deliberately over-contributing because the potential profits could exceed the costs. To eliminate this incentive, legislation adopted in December 2010 introduced an additional benefit tax of 100% on profits resulting from excess contributions with retroactive effect from October 16, 2009.
To further maximize the tax-exempt nature of the account, some investors used swaps where investments in another registered or unregistered account were exchanged for an equivalent value of assets (including cash) in the TFSA. Thanks to this, investments converted into TFSA will be tax-free. Such transactions were prohibited (retroactively) under the same legislation. From that point on, the conversion of registered and unregistered assets into TFSA assets was subject to 100% benefit tax. (Note this transfers between TFSA and other registered accounts are treated as withdrawals and deposits, so swap rules do not apply.)
There are currently a few issues that remain to be resolved for the TFSA that do not hinder longer-term RRSPs. TFSAs are not subject to creditor protection under the Canadian Bankruptcy and Insolvency Act and may be subject to seizure in the event of bankruptcy of the account holder. RRSPs are subject to the protection provided for in the Act, with the exception of contributions made within 12 months of the date of bankruptcy.
However, creditor protection for a TFSA may be available under provincial insurance laws by investing in an insurance company’s product and designating either an irrevocable beneficiary or a family group beneficiary (i.e., spouse, parent, child or grandchild of the annuity). In Quebec, the beneficiary of a family class is the married or civilly-married spouse or ascendant or descendant of the policyholder.
Additionally, the TFSA is not recognized under the Canada-U.S. Tax Treaty, making it a taxable account for U.S. tax purposes. US individuals with a TFSA may face increased US tax filing requirements and possible US taxation of investment income earned within the TFSA. RRSPs are considered retirement accounts under the treaty and retain tax-deferred status for U.S. tax purposes.
Interestingly, the advent of the TFSA required changes to provincial planning legislation. Transfers to a spouse on death are available without affecting the survivor’s premiums.
However, most provincial legislation did not recognize non-spouse beneficiary designations in TFSAs, which meant that these accounts could be subject to probate upon the account holder’s death. Fortunately, this has been amended in all common law provinces and territories to allow such beneficiary designations. Designations for insurance products included in the TFSA were available from the beginning under provincial insurance laws and continue to this day.
In Quebec, transfers at death pass through the estate and are subject to the will of the deceased. Without common law and probate fees, you cannot designate beneficiaries on a TFSA unless it is an insurance-based investment that meets the definition of an annuity, such as a segregated fund arrangement.
Despite a learning curve in the early years, the TFSA has grown in popularity. In 2009, there were 4.8 million TFSA account holders, with a total of 5.3 million TFSA accounts. By 2016 (latest CRA data), the total number of account holders had tripled to 13.5 million, for a total of 18.3 million accounts.
The total fair market value of TFSAs has also skyrocketed from $18.2 billion (2009) to a whopping $232.9 billion (2016). The account’s success, strong capital market conditions and rising contribution limits (the annual limit has been increased twice due to inflation) have helped fuel this tremendous growth. (Fun fact: the annual limit increased to $10,000 in the 2015 federal budget, but as of January 1, 2016, after a change of government, this increase dropped to $5,500. The contribution limit for 2019 is $6,000.)
So what does the future hold for TFSAs? If the RRSP’s 60-plus-year history is any indication, there may be more changes to come, although no one knows what those changes will be. Permanent dollar cap on TFSA annual limit? Lifetime limit on contributions or account balances? Trading restrictions on your account?
No matter what the future holds, the TFSA is likely here to stay. The age-old debate over RRSP contributions or mortgage payments has an additional disadvantage compared to TFSAs that will be discussed at water coolers across the country for years to come. So why not celebrate TFSA’s big 10th anniversary by encouraging customers to make a contribution this year?
