Recently word got out that the federal government will double the annual TFSA contribution limit – from $5,500 to $11,000.
Word of the move has sparked some controversy – some people see this move as a way to reward savers, while others see it as a ploy to buy votes that won’t help the large majority of the population and will cost us in the long term (through lost tax revenues).
Related: Hidden Advantages of the TFSA
No matter what you think about the move, it will impact the finances for most households.
Impact on Generation Y
Those who are opposed to the increase argue that the main beneficiaries of the increase would be the wealthy. Maybe they have a point, considering only 5% of people ages 25-34 have maximized their TFSA. This age group is likely concerned with other costs – saving a down payment to buy a home, paying down student debt, or other large purchases that require some savings like a vehicle.
As a member of generation Y, I’ve found it difficult to juggle mortgage payments, RRSP contributions and TFSA contributions all at once – and the fact that only 5% of our age group have reached their TFSA contribution limit means I’m not alone. We haven’t even started a family yet – young families in our age group have all the extra costs that come with having children, which means TFSA contributions become even less of a priority.
A TFSA limit increase would give young people options when it comes to saving. An RRSP is the preferred saving vehicle for some, but all RRSP withdrawals are taxable. More money to put into a TFSA means young people can earn tax-free investment income while saving for the things they’ll need down the road – a down payment on a house, a new vehicle or the costs of starting a family. The best part is that the money can be withdrawn at any time with no tax implications, giving people more flexibility when it comes to savings.
For those just starting out in the workforce, their marginal tax rates likely won’t be high because their incomes won’t be high. This makes a TFSA the preferred option, and more contribution room means more savings.
Impact on Seniors
The statistics seem to point to seniors as the biggest beneficiary of a limit increase.
CRA reported that 71% of those ages 55 or older have reached their TFSA contribution limit and the age group with the highest proportion of TFSA accounts is 75+. This could mean the increased contribution room will be used by seniors to help generate some investment income tax-free.
You probably know that an RRSP needs to be converted to a RRIF later down the road and that minimum withdrawals then kick in – creating the possibility of higher taxes.
An increase in the TFSA contribution limit could potentially lower the taxes for some seniors, here’s how: they could slowly draw down their RRSP balances before converting it to a RRIF even if they don’t need the cash, and then put the money into their TFSA to be used in the future. This could lower their tax rates because they’d be drawing down their RRSP over a longer period of time, which would lower their marginal tax rates in the years before converting their RRSP to a RRIF.
Some are worried that the limit increase would only benefit the wealthy, who would be in the best position to maximize their TFSAs while others aren’t able to. The RRSP was created in 1957 and despite this 94% of contribution room is unused. This makes me believe that many people wouldn’t even fully take advantage of a TFSA limit increase, which means the estimated cost of about $15 billion per year by 2060 might be on the high side (since many people likely wouldn’t even reach the TFSA contribution maximum).
An increase to the TFSA contribution limit would likely mean we’d start focusing more on the TFSAs than RRSPs. We wouldn’t completely neglect the RRSP because of the tax-free growth it can provide, but there’s no doubt the TFSA has some serious growth potential.
In reality though, we’d be hard pressed to reach the TFSA contribution limit – at $22,000 per year ($11,000 per account) we wouldn’t be able to contribute that much without taking money away from personal spending, RRSP contributions or emergency savings – something we aren’t willing to do.
Our goal would be to make RRSP and TFSA contributions, and then use the annual tax refund generated by the RRSP contributions to put towards the TFSA.
Conclusion: the TFSA limit increase is controversial; some people believe it will only benefit the wealthy while others believe it’s a way to reward savers. For us, it would be a great opportunity to save in the long run but we likely wouldn’t be able to reach the annual contribution limit without sacrificing spending in other areas.
How would a TFSA contribution limit increase affect you?
Related: Will Your TFSA Be Audited?