Tax Free Savings Plans: Resisting Temptation
Arthur Drache, December 14, 2008
January 1 will bring into being the legislation which creates the Tax Free Savings Plan, the centrepiece of the 2008 federal budget. As all readers are likely well aware, this plan allows anybody 18 and over to contribute up to $5,000 a year into the plan. Contributions are not deductible but the income received from the plans is not taxable. An additional $5,000 may be contributed in each succeeding year. There is no income attribution applicable so one spouse can found the other spouse’s plan without tax consequences. Because withdrawals are tax free the income has no impact on income based entitlements.
If one doesn’t use the plan in any year, there is a carry forward of eligibility. If you withdraw funds, the amount of the withdrawal will increase eligibility in a future year.
There seems to be no downside whatsoever and the moiré sophisticated advisers simply help taxpayers make a choice between the TFSP, a RRSP or even a registered educational savings plan.
Banks and other carriers even jumped the gun, offering investments (usually fixed rate instruments) in late 2008 which would be automatically transferred into a TFSP on the first banking day in 2009.
But we have had some questions in our own mind.perhaps because we still have some eligibility for RRSP contributions.
It all boils down to what’s the hurry?
The attraction of the TPSP lays in building up tax free capital accumulation. If a TPSP doubles in a couple of years, this is windfall money. But given the markets as they are today, the issue seems to be whether one wants to lock in funds for one to three years at (if you’re lucky) four percent? On the other hand, if you decide that the equity markets will bounce back, is this a good time to pick up some bargains which will generate potential big gains? Maybe that’s a gamble worth taking but remember that if there are losses in the plan, they cannot be used to offset personal capital gains.
We note the following:
. Buying equities at the start of 2009 may or may not be a big risk?
. Buying debt instruments will generate some fairly puny yields. Of course these investments may be converted to equities in the future but you have to identify the costs of cashing in early or having to wait until they mature.
. There is no tax benefit associated with TFSP associated with timing as they is with the RRSP deduction or the payment by the government of up to $500 annually with a RESP.
. If you don’t use the $5,000 TFSP room in 2009, you’ll have $10,000 of room in 2010.
Had things looked as good as they did for investments when the plan was first announced, we probably would have been first in line to invest now. But given how things are in the market and in the economy, it seems easy to resist quick action. Of course there may still be some people around who have maximized RRSP contribution room (or because of age cannot contribute) RESP room or children or grandchildren and are either big risk taker in equities or ultra conservative in assessing debt instrument returns. For them, being first in line for the TFSP may make sense.
For most others waiting has virtually no cost unless you anticipate a big bull market starting around the beginning of February.