Tag: Saving

TFSA goes back to the future

Rollback, indexing and the next instalment

In case you missed it, last October marked a long-awaited historic event: Marty McFly’s cinematic visit to the future on October 21, 2015 in the second instalment of the 1980s’ Back to the Future trilogy.

We introduced our kids to this movie franchise over the course of three weekends recently, and it was time well spent. Apart from the amusement, there was also a fair bit of confusion as they tried to work through what came first, what changed and what remained the same.

It’s not unlike how many people may have felt about the future of the tax-free savings account (TFSA) following that other significant event last October – the Liberal party victory in the federal election.

In the beginning

The TFSA was introduced by the Conservatives in the 2008 Federal Budget. Beginning in in 2009, it provided each Canadian resident over the age of 18 with $5,000 of annual tax-sheltered investment room. 

To keep up with inflation, an indexing formula was established to enable the annual room to rise by $500 increments every few years. The first such increase occurred in 2013 when the allotment became $5,500.

A bump in the road

In the 2011 election campaign, the Conservatives included a promise to double the annual TFSA contribution limit. The promise was made contingent on the party having a full term in office and reaching a balanced budget. They won a majority, so the only remaining requirement was to balance the books.

With the intervening 2013 increase to $5,500 based on the formula, there was potential for the room to be increased to as much as $11,000. As it turned out, the Conservative government tabled a balanced budget in March 2015 that included an increase in annual TFSA room to $10,000, retroactive to the beginning of 2015.

Part and parcel with the increase, indexing was removed, setting $10,000 as the fixed figure for all years from 2015 on. For interest, if the annual index factor were to have been a consistent 2% in future (see the table for the actual past figures), it would have taken close to 30 years to build up to $10,000 – roughly the same span of time Marty McFly jumped ahead in his time-travelling DeLorean.

Back to the future

It would be a bit overreaching to cast TFSA room as a pivotal issue in the 2015 election campaign, but it likely swayed some voters and certainly was prominently discussed. While the Conservatives had proceeded to enact the increase prior to the election call, the Liberal party stated its intention to rollback the provision.

With the Liberal majority victory this past October, attention turned to what the “rollback” might mean. If it was returned to $5,500 retroactive to the beginning of 2015, that would have forced those who had used the excess room to extract the extra they had deposited. And how would any investment growth (or decline) be treated? On the other hand, would those who had not yet taken advantage of the excess room lose that opportunity?

The answer was a practical one. The indexing formula was simply reinstated for 2016, returning the annual room to $5,500. The 2015 allotment of $10,000 was allowed to stand for the purpose of any carryforward, but it was ignored in applying the index formula. This assured that there was no prejudice to those who had not used the room in 2015 and no administrative headaches for those who had.

And for those lamenting the loss of the $10,000 amount, if that same 2% indexing assumption applies, the bump to $6,000 should happen in 2018.

Annual TFSA room

Saving for a home – Debate between HBP and TFSA heats up

It is an age-old debate in personal finance whether it is more cost-effective to rent or buy a home — then add in the emotional element.  Assuming the ultimate decision is to buy, attention then turns to assembling the downpayment.  

Looking past the bank of mom and dad, traditionally that meant building up a reserve in a non-registered account beginning years ahead of the intended purchase.  As such deposits are after-tax savings subject to annual taxation on earnings, that could make for a slow exercise.  

Since 1992, accumulation in a registered retirement savings plan has been available for this purpose through the Home Buyers’ Plan (the HBP).  And since 2009, the multi-purpose tax-free savings account has provided another avenue.

While RRSP and TFSA both offer tax-free accumulation, the pre-tax RRSP allows greater gross accumulation, which would seem to favour usage of the HBP.  On closer look however, the choice is neutral at best, and in my opinion instead leans toward employing the TFSA.  

The simplicity of TFSAs

The TFSA became available for deposits in 2009.  The initial $5,000 annual contribution limit increased through indexing to $5,500 in 2013, and earlier this year was moved up to $10,000 (though it will no longer be indexed).  Depending on the outcome of the current federal election, TFSA room may be further adjusted, but there is no suggestion that either the program itself or its tax functioning are at risk.

The TFSA is funded out of after-tax money, so less money is available to go into a TFSA compared to an RRSP deposit.  To illustrate, a person at a 35% marginal tax rate who had a dollar to put into an RRSP (assuming available room), would have only 65 cents to go into a TFSA.  This is a double-edged sword for the RRSP though, as all deposits and all growth will eventually be taxable.

On the other hand, TFSA withdrawals are not taxed.  Thus the amount available for a downpayment is simply the value of the TFSA at any given time.  Once a withdrawal is made, there is no service cost or repayment obligation, and the taxpayer is entitled to a dollar-for-dollar credit for re-contribution the year following withdrawal.

HBP accessing RRSPs

At its core (without getting into all the minutia), the HBP allows a first time home buyer to make a withdrawal from an RRSP without facing current taxation.  The original withdrawal limit of $20,000 per person (or as much as $40,000 for a couple) was increased to $25,000 in 2009, and there is now an election proposal to further increase it to $35,000.

The quid pro quo is that the withdrawn amount must be returned to the RRSP over the 15 years following the home purchase (or sooner if the person is able, and wishes to do so).  Those future replenishing payments are not deductible. 

For a renter anxious to enter into home ownership, the HBP opens the door to a larger pot of money to achieve a desired downpayment.  This could be particularly helpful in getting past the threshold below which an insurance premium would be payable for the mortgage to be covered by the Canadian Mortgage and Housing Corporation.  And obviously a larger downpayment means a smaller amount being financed.

This last point is critical, as larger annual interest charges eat into a household budget for years, and often decades.  But what is the trade-off cost of using the HBP for that downpayment?  

Just as mortgage payments are non-deductible, again so too HBP repayments.  Put another way using our 35% taxpayer once more, roughly $1.50 of the person’s pre-tax income would be required to fund each repayment dollar.  To derive a truer cost of financing, an aspiring  homeowner would be advised to budget based on the combined cost of mortgage and HBP.  

Still, whereas mortgage payments are mandatory (in a practical sense), couldn’t a person simply forego one or more HBP repayments if things get tight?  The answer is yes, but then the un-repaid amount is taken into taxable income – And remember, no cash comes available at that time, as it was spent years earlier to buy the home.  The tax payment itself is not deductible, costing our erstwhile 35% homeowner almost 75 cents of pre-tax income to pay the roughly 50 cents of tax.  And unlike TFSA room, spent RRSP room is non-recoverable.

It is also bears mentioning that likely our homeowner will have higher income in future.  While plainly positive on its own, as household costs ascend that could have an impact on the cost of HBP repayment or tax on un-paid instalments.  The net effect is ambiguous at best.

Transparency trumps 

Perhaps the picture offered here is a bit cynical.  Well-informed, well-disciplined purchasers may very well be able to navigate the HBP rules without harm, and possible to their advantage. Indeed, a couple planning a family could strategically manage the program so some future income is recognized by a low-bracket stay-at-home parent.  

Even so, the true cost of the HBP remains opaque and uncertain – an uncomfortable position to be in for the largest financial transaction of a person’s life.  For my money, the nod should go to the greater transparency and certainty of the TFSA, maybe with the HBP playing a minor supporting role.

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SIDEBAR/CALLOUT

According to Statistics Canada, 180,750 taxpayers did not pay their HBP instalment in 2012 (the last year for which data is available), collectively taking $812 million into income that year. 

Would increased CPP actually increase savings? – Some sobering thoughts

I vividly recall one summer session when my economics professor stopped mid-sentence, turned from the blackboard and locked a distant gaze out the window. “Ah, there it is,” he uttered in a longing fashion, then slowly turned back toward the handful of us in attendance.

You see, he and an old college mate had agreed anytime either was back at their alma mater, he would raise a cold one — or a warm one, being British — at the local pub. It was at that moment with chalk in hand that my prof had sensed he was being toasted. And with that, at his behest we adjourned to the patio of our own campus watering hole for the remainder of the day’s lesson so he could reciprocate.

True story. But apropos of what, you might ask?

Well, in the midst of reading yet another article on the condition of our retirement system, and specifically on the state of the Canada Pension Plan, I had my own ‘Ah’ moment. 

If and how to improve CPP

For some time now, and certainly since the 2009 release of the Retirement Income Adequacy Research papers, our pension and retirement system has been under the microscope. Whether this scrutiny arises out of a true crisis, or is merely coming to the fore due to the demographic truth about boomers breaking 65, this public dialogue will be with us for years and decades to come. 

In due course the CPP has garnered attention, both in terms of what it currently offers and what it may offer prospectively in response to any determined shortcomings. Chief among the issues under consideration are whether we’re saving adequately, investing effectively and living within our means, both before and during retirement. 

To show my colours, I’m firmly a fan of the CPP. It delivers forced savings, eliminates the necessity for investment decisions, and provides a guaranteed base level retirement income. To some this may smack of paternalism. And if our entire retirement system were so prescribed, I would agree wholeheartedly. In its current form, however, I believe it provides both individual and community benefits, and does so well within the borders of trampling on personal prerogative. 

But what about an expanded CPP? In the article I was reading, the author referred to CPP premium cost being shared equally between employers and employees. And that’s when it hit me: ‘Ah’ and I was back on that patio.

Incidence and payroll tax

Now I can’t say for certain what topic we drank to on that sunny afternoon, but the event was sufficiently memorable to remind me of tax incidence — the concept that a party who pays a tax may not be the one who bears its full cost. The true burden depends on elasticity of demand and supply, such that there may be a shift between parties based on relative economic power.

Carry this over to the employment context. It’s a longstanding debate whether payroll taxes imposed on employers may actually be borne partially or entirely by employees over the long term — the notion being that there may be a corresponding suppression of long-term wage increases. I leave it to economists whether, and to what degree, this may apply in our system generally, and in a given workplace specifically.

On the face of it, an expansion of the broad-based CPP intuitively appeals to a sense of fairness. It is not so clear, though, how the ultimate cost will be borne. Even if the net effect across the economy is neutral, the dynamics of each workplace will be varied. 

Indeed, it is conceivable for some employees that it will serve to invisibly siphon future pay raises over to CPP. That’s not necessarily a bad thing, just something to be understood. 

Me, I continue to root for CPP improvements as part of the solution, but remain open to sober reflection as the dialogue lingers.