Belated happy 10th anniversary, TFSA

This year marks the tax-free savings account’s 10^th anniversary. While the TFSA has given Canadians a powerful tax-free investment option, it has not been without its growing pains. Just like its older sibling, the RRSP, the TFSA has experienced tremendous change in its first decade.

The TFSA’s introduction at the beginning of 2009 provided a great opportunity for tax-free investment. With the markets nearing their bottom after the 2008 financial crisis, investors were poised for attractive returns. However, the contribution limit was only $5,000 per eligible Canadian resident.

Over-contributions were a point of early confusion and frustration. The penalty was clear enough: 1% per month for excess contributions. But confusion about contributions and withdrawals within the same calendar year may have stemmed from the fact that TFSA limits were originally reported on the Canada Revenue Agency’s (CRA) notices of assessment, a method filled with inaccuracies and quickly replaced with reporting through CRA My Account.

Common problems included recontributing—withdrawing from a TFSA and contributing again the same year, when the limit had already been maximized—and having TFSAs with multiple financial institutions where total contributions exceeded the limit.

By June 1, 2010, the CRA had issued more than 72,000 notices of over-contributions and penalty tax owing for the 2009 tax year. The following year saw nearly 103,000 notices sent for possible over-contributions.

The agency waived penalties on a case-by-case basis but this was a painful early lesson for all parties.

Beyond the confusion, the 1%-per-month penalty didn’t stop some investors from intentionally over-contributing, since potential profits could exceed the cost. To eliminate the incentive, an additional 100% advantage tax on the profit from over-contributions was introduced in legislation passed in December 2010, retroactive to Oct. 16, 2009.

To further maximize the tax-free nature of the account, some investors were utilizing swap transactions where investments in another registered or non-registered account were swapped with an equivalent asset value (including cash) in the TFSA. This would allow the investments swapped into the TFSA to grow tax-free. Such transactions were disallowed (retroactively) under the same legislation. From that point on, swaps of registered and non-registered assets with TFSA assets were subject to a 100% advantage tax. (Note that transfers between TFSAs and other registered accounts are treated as withdrawals and contributions, so the swap rules do not apply.)

Today, a couple of issues remain for TFSAs that don’t hinder the longer-tenured RRSP. TFSAs are not afforded creditor protection under Canada’s Bankruptcy and Insolvency Act and could be subject to seizure if the account holder becomes bankrupt. RRSPs are protected under the act except for any contributions made within 12 months of declaring bankruptcy.

However, creditor protection for the TFSA may be available under provincial insurance acts by investing in an insurance company product and naming either an irrevocable beneficiary or a beneficiary of the family class (i.e., a spouse, parent, child or grandchild of the annuitant). In Quebec a family class beneficiary is the married or civilly unified spouse, or ascendants or descendants of the policyholder.

Also, the TFSA is not recognized under the Canada-U.S. tax treaty, making it a taxable account for U.S. tax purposes. U.S. persons with TFSAs may have the burden of increased U.S. tax filing requirements and possible U.S. taxation on the investment income earned within the TFSA. RRSPs are recognized under the treaty as retirement accounts and retain their tax-deferred status for U.S. tax purposes.

Interestingly, the TFSA’s arrival required changes to provincial estate planning legislation. Transfers to a spouse at death are available without impacting the survivor’s contribution room.

However, most provincial legislation didn’t recognize the designation of a non-spouse beneficiary on a TFSA, which meant these accounts could have been subject to probate when the account holder passed away. Thankfully, this has been amended in all common-law provinces and territories to allow such beneficiary designations. Designations made on insurance products held in a TFSA have been available under provincial insurance acts from the beginning and continue today.

In Quebec transfers at death pass through the estate and are governed by the deceased’s will. With no common-law and no probate fees, beneficiary designations can’t be made on a TFSA unless it’s an insurance-based investment that meets the definition of an annuity, such as a segregated fund contract.

Despite the learning curve in its early years, the TFSA has grown in popularity. In 2009, there were 4.8 million TFSA account holders with a total of 5.3 million TFSA accounts. By 2016 (the latest CRA data) the total number of account holders had tripled to 13.5 million with a total of 18.3 million accounts.

The total fair market value for TFSAs has also exploded from $18.2 billion (2009) to a whopping $232.9 billion (2016). The success of the account, strong capital market conditions and growing contribution limits (the annual limit has been increased twice due to inflation) has helped fuel this tremendous growth. (Fun fact: the annual limit increased to $10,000 in the 2015 federal budget, but that increase fell back to $5,500 effective Jan. 1, 2016 after a change in government. The limit for 2019 contributions is $6,000.)

So, what does the future hold for the TFSA? If the RRSP’s 60-plus years of history are any indication, there could be more change, though what those changes will be is anybody’s guess. A permanent dollar cap on the annual TFSA limit? A lifetime cap on contributions or account balances? Restrictions on trading activity within the account?

No matter what the future brings, the TFSA is likely here to stay. The age-old debate of contributing to an RRSP or paying down a mortgage has the added wrinkle of the TFSA comparison, to be debated at water coolers across the country for years to come. So why not celebrate the TFSA’s big 10th by encouraging clients to make a contribution this year?

Curtis Davis

Tax & Estate

Curtis Davis, FCSI, CFP, TEP, is director for tax, retirement and estate planning services, retail markets at Manulife Investment Management.