8 Ways The TFSA Could Change In The Future
Fee-for-service financial planner and founder of PlanEasy.ca
When you’re thinking about your financial future it’s important to consider risk. There are your typical risks, like the risk of losing money with investments, the risk of passing away unexpectedly, or the risk of not being able to work for an extended period of time. These are all common risks we need to plan for.
But there are also other risks too, ones that many of us might not include in our plans. These risks are less common, more speculative, but can be just as damaging. Risks like changes to government benefits, increasing tax rates, or changes to tax-advantaged accounts like the RRSP and the TFSA.
Based on age alone, the TFSA is relatively young, it’s barely entering the double digits. Although it was only introduced in 2009 it has already experienced a few dramatic changes during that time.
Anticipating changes to tax-advantaged accounts is an important part of any financial plan. A good plan should have enough room to absorb a few of these unexpected changes without causing major stress.
To ensure your plan is robust you need to anticipate these changes and understand how they might impact your plans.
In this post we’re going to speculate on a few ways that the TFSA could change in the future. This is pure speculation but it’s a good exercise to understand what changes might be possible in the future and how your plan can absorb them if they were to actually happen.
1. A Cap On Annual Contribution Room
Currently TFSA contribution room escalates with inflation. This doesn’t happen every year but happens at $500 increments. With the inflation escalator there is essentially no limit on how large that annual contribution room can become in the future. But this wasn’t always the case.
For a short period of time the TFSA was changed to a flat contribution of $10,000 per year with no increase. That meant that each year the TFSA became less and less valuable due to inflation. However, that was quickly reversed back to the original ~$5,500 with the inflation escalator.
One way the TFSA could change in the future is that a cap could re-introduced. It could be that TFSA growth will be capped at $6,000, $8,000, $10,000 or $12,000 per year. This wouldn’t have a large impact now but would decrease the benefit of the TFSA in the future as inflation erodes contribution room.
2. Contribution Room Decreases With Income
The TFSA was originally touted as the perfect account for low-income earners. While the TFSA is certainly an amazing account for low- and moderate-income households, at the moment TFSA usage hovers around 40% of the population. This means that a large chunk of people in Canada are not benefiting from this tax-advantaged space.
The people who are really benefiting from the TFSA are those who can maximize their TFSA contributions each year. Households with a higher than average income will find it easier to maximize their tax-free space. To get back to the original goal, one change that could be put in place is that annual contribution room will decrease with income. The higher your individual income the lower your annual contribution room becomes.
This of course would be difficult to manage but not impossible, the government is already used to managing contribution room for RRSPs based on income (although in the opposite direction), so managing TFSA contribution room based on income isn’t too big a stretch.
3. Contribution Room Gets Destroyed After Withdrawal
One of the major benefits of the TFSA is that contribution room isn’t destroyed after you make a withdrawal. When you take money out of your TFSA this amount gets added back to your new contribution room on January 1st of the following year.
This is drastically different than the RRSP. If you make a withdrawal from an RRSP that tax-advantaged space is destroyed FOREVER.
One way the TFSA could change in the future is that withdrawals are no longer added back to your contribution room on January 1st. As people make withdrawals this would reduce the amount of TFSA space available.
4. Lifetime Limit on Contributions
Another change that could affect the TFSA is that a lifetime limit is placed on contributions. This already exists, just not for the TFSA. RESP’s have a lifetime contribution limit of $50,000 per child. It doesn’t matter when you put that money into the RESP, you could put $50,000 in immediately, or you can spread it out to maximize government grants, but there is a hard cap at $50,000.
This same principal could apply to the TFSA. Rather than having contribution room grow annually, there might be a hard limit in contributions. Once you hit that limit you can no longer make contributions. Accounts could still grow based on investment gains, but contributions get capped at a certain amount.
At the moment this tracking already exists for RESPs. Financial institutions need to track contributions, grants and growth separately. Extending this to the TFSA wouldn’t be a huge stretch either.
5. Limit on Account Size
Rather than limit contributions, the government may choose to limit the account size to a certain amount, maybe $250,000 for example. Investment gains above this amount could be included as taxable income each year.
Introducing this rule would limit the usefulness of the TFSA for wealthy individuals. Above a certain level, like the $250,000 example, the TFSA would act more like a non-registered account. It would still remain useful for less wealthy individuals because they may not have the means to max out both their TFSA and their RRSP, but for individuals who can maximize both the TFSA and RRSP the benefit would decrease.
6. Withdrawals Included in Retirement Benefit Calculations
The TFSA is one of the best ways to save for retirement, especially for those targeting low or moderate retirement income (roughly at or below $50,000-$60,000 per year). Because withdrawals are not included when calculating government benefits, using a TFSA can help you avoid the crazy 50%-75% claw back rates on some retirement benefits. Because ~30% of seniors receive these benefits, they can use the TFSA to greatly improve their after-tax income in retirement.
The TFSA is great for low- and moderate-income earners but if you do some fancy financial planning it’s possible for moderate to high income earners to retire with $1M in their TFSA, report zero income on their tax return, and qualify for maximum retirement benefits. In the future the government may prevent this by including TFSA withdrawals as income for benefit calculations. The problem here is that it impacts both high and low-income earners, so this change seems unlikely, but still possible.
7. Account Size is Factored into Retirement Benefit Calculations
Another way the government may restrict access to retirement benefits is by adding a “means” test that could include TFSA assets. To qualify for retirement benefits like GIS, or perhaps even OAS, the government could introduce a claw back based on how much you have in financial assets, TFSA included.
If this were to happen, the larger your TFSA balance becomes, the smaller your possible government benefits will be. This could impact individuals who have large TFSA balances but report very low taxable income. These benefits can be worth $10,000+ per year, so this impact could be large for certain households.
8. Mandatory Withdrawals Based on Age
Mandatory withdrawals already exist for other retirement accounts, this could easily be introduced for the TFSA as well. At the moment the TFSA can grow unrestricted forever. With the power of compound interest this will lead to some massive TFSA accounts in the future. To limit this the government could introduce mandatory withdrawals after a certain age.
This already exists for retirement accounts. After a certain age there are mandatory withdrawals (whether you need this income or not). These mandatory withdrawals are a % of the account balance and escalate each year. By the time you reach age 95 these mandatory withdrawals are 20% of the account balance each year. This severely limits the size of these accounts as you age and if the same rule was applied to the TFSA it would have a similar effect.
This Is All Pure Speculation
Of course, this is all pure speculation. There has been no indication that the TFSA will change in the future, and there is no need to make drastic changes to your plan, but its important to anticipate how tax laws, regulations, government benefits and tax advantaged accounts can change in the future.
If any of these changes cause a large disruption to your future plans, then you may need to revisit your goals and ensure you have enough flexibility to absorb these unexpected disruptions, whatever they end up being.
Financial planner, personal finance geek and founder of PlanEasy.