In an interview with Jon Chevreau of the Financial Post, actuary Malcolm Hamilton proposed adding retroactive contribution room to a TFSA to help more Canadians save for retirement. Here’s how the proposal would work: $5,000 of contribution room would be added for every year since age 18 to the 2010 TFSA contribution room. For instance, someone who is 55 years old in 2009 would have an extra $180,000 worth of contribution room added to their TFSA next year. According to Mr. Hamilton, the move would help Canadians save more in a tax efficient manner to make up for the bear market losses just as defined benefit programs are allowed to boost contributions to make up for a pension plan shortfall. Here’s why I think this isn’t such a great idea after all:
- It compares apples to oranges. Mr. Hamilton is comparing defined benefit (DB) plans with defined contribution (DC) plans. The two plans are completely different beasts and it doesn’t make much sense to compare just one narrow aspect of one plan with the other.
- It will set a bad precedent. If the Government provides retroactive TFSA room to help recover from the losses of the current bear market, what happens when the next one comes along? What will investors demand next?
- It presumes capital losses only by looking at the peak market values. Investors who are close to retirement should have a healthy allocation to bonds. They shouldn’t complain if they took on more risk to boost returns and got burned in the process. Also, if investors calculated their returns based on the amounts they invested over time and the current market value, they may not even show a loss. So, what exactly does the proposal plan to redress?
- It doesn’t benefit the vast majority of Canadians. The person who benefits the most would be one who has no RRSP room and holds significant assets in a taxable portfolio. The vast majority of Canadians don’t fall in that category — they have plenty of unused RRSP room and simply don’t save enough to take advantage of any extra contribution room.
- It is likely to be expensive. The proposal is likely to result in a significant loss of tax revenues. Budget 2008, which introduced the TFSA estimated that the savings plan will cost the government $3 billion annually in 20 years. I don’t know exactly how much the retroactive TFSA idea would cost but I won’t be surprised if it is comparable to the $3 billion estimate. It may seem insignificant compared to $250 billion in expenses but at a time when the Government is running big deficits, it doesn’t seem prudent to spend even more money.
- It disproportionately favours older Canadians. TFSA, as it currently exists allows a gradual accumulation of contribution room over time. If it ever becomes too popular, the Government would look for ways to limit the advantages. For instance, the Government could mandate a maximum lifetime contribution limit. Providing retroactive contribution room in the name of fairness assumes that the plan would exist in its current form forever. It may not.
- It unfairly affects younger Canadians. As noted earlier, the proposal is likely to result in a significant loss of tax revenue. The loss will be made up elsewhere — either current taxes or future taxes, which would be borne by younger Canadians.