Federal Government Increases Annual TFSA Contribution Limit to $10,000
After years of promises, our Conservative party government has finally done it. No, we are not talking about balancing the budget. We are talking about something even more important to Canadian investors. Stephen Harper and his Tory’s have delivered on their promise to increase contribution limits for the Tax Free Savings Account (TFSA).
Going back to even before the Conservatives were elected to their majority government, they made a promise to Canadians that they would double the TFSA contribution limit once they had the budget balanced. Now, we have heard tempting promises from politicians before (ummmm…remember their promise not to touch the Income Trust structure) and have learned over the years not to get too excited until the package is delivered. But on Monday, April 20th, the government announced that they were increasing the annual contribution limit for TFSAs to $10,000 (from $5,500) – effective immediately.
Okay, so this wasn’t exactly a doubling of the TFSA contribution limit (an 82% increase in fact). But technically speaking, it is double the amount of the contribution limit at the time that the Conservatives starting making the promise. In any event, we consider this to be great news and highly beneficial for Canadian investors.
For those that would like a refresher, the TFSA is a tax-free investing account that was started in 2009. Initially, the annual contribution limit was $5,000 but it increases over time with inflation in increments of $500 (the limit went up in 2014 to $5,500). The way that it works is you contribute (up to your limit) with money that has already been taxed. Any investment returns generated inside of the TFSA accrues tax free and investors don’t pay taxes on any withdraws either. This makes the TFSA a very powerful tool for increasing investment returns and portfolio size over time. Any unused contribution room from previous years can also be carried forward to future years indefinitely. Any withdraws can also be re-contributed in future years (you just have to wait until the next calendar year to do so). Another attractive attribute of the TFSA is that (unlike the RRSP) withdraws in future years do not count as income and will not affect eligibility for federal income-tested benefits and credits, such as Old Age Security, the Guaranteed Income Supplement, and the Canada Child Tax Benefit. See www.tfsa.gc.ca for more details.
That all sounds great doesn’t it? Well, unfortunately not everyone loves the increased TFSA limits. The most notably opponents are (not surprisingly) the government’s two opposition parties (the Liberals and NDP). Of course it is the job of any political party to automatically disparage the policies and actions of their chief opponents.
Politics aside, the main criticism seems to be that as the TFSA continues to grow, the lost tax revenue for the government will cause a significant budget shortfall. Unlike in an RRSP (which is only a tax deferred account), any investment returns or withdraws from the TFSA will never be taxed (theoretically). We think that these claims are exaggerated and don’t provide the full picture of what happens when more people invest. One point that seems to be missing from this argument is higher TFSA limits will likely (certainly should) encourage higher levels of saving and investment. Economic growth is a function of a country’s savings and investment rate (which in Canada are at meager levels) and higher levels of economic growth and GDP translate into greater tax generating potential for the government. We also have to take into account that when people make withdraws from their TFSA they typically do so with the intentions of spending that money. Money spent in the economy is taxed at the time that most products and services are purchased and then again when it flows through the companies that provide those products and services – as corporate tax and income tax paid by employees (who have a job because these products and services are being purchased). Of course, future governments will always have the option to take certain actions if several years (or decades) down the road TFSA contributions do start getting out of hand. But if there is so much capital inside this structure that it makes a significant impact on government revenues then that means more capital is being saved and invested which is a positive driver for the economy long term.
At this point, our biggest concern over the higher TFSA contribution amounts is that it might make the TFSA a target of future governments. Although the thought of substantially negative change to the TFSA structure sends ripples of fear down my spine, the very possibility that this could happen is only more reason to start maxing out your contributions today and generate those tax free returns while you can.
