TFSAs Driving Up Costs for Pension Benefits?
A popular savings program created by the federal Conservatives is exacerbating the fiscal pressure on public pension benefits -- even as the government prepares to scale back benefits.
Prime Minister Stephen Harper set up tax-free savings accounts or TFSAs in 2008 to encourage savings, allowing adults to set aside up to $5,000 a year to grow tax-free.
The accounts have surged in popularity, and in the last election, Harper pledged to double the maximum annual amount, once the budget is balanced.
The fiscal problem is that when retirees start taking money out of their TFSA plans, none of that income is included in calculating whether they're eligible for Old Age Security or the Guaranteed Income Supplement.
So there's a big incentive for working people to save money in TFSAs while knowing they will still qualify for GIS when they retire -- even if their income from their TFSA plans is high, says pension expert Keith Horner, a former Finance Department official.
He says if everyone who can takes full advantage of the TFSA-GIS trade-off, the costs of the GIS would skyrocket to about 84 per cent above official projections by 2030.
Horner is quick to acknowledge not everyone will take up the option.
But given the tax incentives embedded in the savings plans and the fact private-sector pensions are becoming less prevalent, the take-up on TFSAs is expected to be large, and Horner's numbers speak to the huge potential cost.
"The GIS is a real issue," Horner said in an interview.
"Governments should take these projected longer-term fiscal consequences of the current TFSA rules into account when assessing pension reform options," he adds, in a major paper for the Institute for Research on Public Policy.
Indeed, the government's chief actuary has also examined the numbers, and issued similar warnings.
In his 2009 assessment of Old Age Security, actuary Jean-Claude Menard found that the TFSA trade-off will cost the federal government an extra $4.2 billion annually by 2050.
His numbers are not as alarming as Horner's. But in a speech last fall, Menard put the government on notice that his numbers are preliminary and would be revised when he gets a better grip on the take-up of TFSAs.
"The projected impact of TFSAs will grow over time as people gradually adjust their saving behaviour," he says in a slide. He adds in bright blue letters: "TFSAs assumptions will be carefully monitored and adjusted in future, if needed."
The GIS is a maximum of $665 a month for a single senior, but the amount is reduced and eventually eliminated based on income. TFSA income is not included, even though it could amount to $1 million in savings over the lifetime of a diligently saving individual.
Harper announced last month in Davos, Switzerland, that the current retirement system will be fiscally unsustainable because of the aging population, and the dwindling number of taxpayers. He vowed to reform the system.
The next budget is expected to include firm direction on where he is heading with the reforms, centred on raising the age of eligibility for OAS and GIS -- an idea that has prompted the beginnings of a backlash within the Conservative caucus.
Indeed, Harper's premise -- that the OAS-GIS system is unsustainable, and status quo would bankrupt Ottawa -- has been widely challenged.
In his fall speech, the chief actuary's main message was that Canada's pension system is well established, efficient and far sturdier than many other countries' systems.
In Edinburgh for a pension conference, Menard said the future costs of OAS are sustainable partly because future increases are not expected to grow as fast as wages.
"Over the longer-term, the inflation-indexed benefits will grow at a slower pace compared to wages, which will in turn lead to an increased sustainability of the program," Menard says.
In other words, an individual's OAS and GIS payments increase along with inflation. But over the medium and long term, wages are finally expected to start growing even faster than inflation, as labour shortages grow more acute.
So the tax base will be growing at a faster clip, helping to support the program. And OAS will take on a decreasing role in replacing the income of retirees.
In his address that sought to put Canada's pension system in an international context, Menard noted that other countries are raising the pensionable age. But he did not note any need in Canada to follow suit.
Rather, he framed Canada's system as "efficient," with a "reasonable economic cost" that was set to rise only modestly over the long term.
He produced a table showing that the burden of public pensions in Canada is one of the lightest in the developed world.
In 2010, public spending on pensions was five per cent of Canada's gross domestic product, set to rise to 6.6 per cent in 2030, and than fall back to 6.3 per cent in 2050, the table shows.
The data is taken from the Organization for Economic Co-operation and Development.
Compared with other countries, Canada's current burden is reasonable. But by 2030, other countries will see their public-pension burdens rise much higher than Canada's. And by 2050, only Australia and United States will see their burdens fall below Canada's, at just under five per cent in both places.
You can view the latest speeches and presentations by Jean-Claude Ménard, Canada's Chief Actuary, by clicking here. I've met him while working at PSP Investments and hold him and his Office in high regard. He's extremely intelligent, balanced, open and transparent. The OCA's website should be the gold standard that every government department and Crown corporation uses to disseminate information.
And while he may be right that there is no pressing need for Canada to follow other countries in raising the pensionable age, people are living longer. I agree with David Dodge, the former governor of the Bank of Canada and believe this option must be put on the table.
I'm tired of the politicization of OAS. We are arguing about stupidities instead of rolling up our sleeves and focusing on meaningful pension reform that will increase the coverage by expanding CPP and bolstering our defined-benefit plans. Some of our best pension managers have made the case for boosting DB pensions and we're still stuck on silly ideas that RRSPs, PRPPs and TFSAs will save us. Nothing can be further from the truth.
Don't get me wrong, I love TFSAs and so do many Canadians who want a tax free savings vehicle, but we're dreaming if we think that increasing the amount will help people retire in security. Why? Individuals still have to save and invest that money, just like RRSPs (Canadian 401k). They typically invest in some crappy mutual fund delivering mediocre performance and get eaten alive on fees. I believe they're better off investing with a large DB plan that can pool resources, lower costs and invest directly and indirectly in public/private markets and absolute return strategies.
Bob Field shared this comment with me:
You don't get a tax deduction when you put your money into a TFSA so the government gets it money up front but with an RRSP or pension, the government gets it money at the end. If you just bury your money and then dig it up when you retire you're not taxed on the original capital and it doesn't figure in GIS, so the only theoretical issue should be the treatment of the interest. If we could get a better CPP it would largely eliminate the GIS problem as few people would need it.I agree, the GIS problem wouldn't exist if we can get better CPP coverage. Unfortunately, we are going to have to endure endless debates on the OAS and GIS, tinkering at the margins, instead of getting on with some real, long-lasting pension reforms that will make a meaningful difference in the lives of millions of Canadians falling through the cracks.
Finally, Bernard Dussault, Canada's former Chief Actuary, shared these comments with me:
Below, more squabbling on Old Age Security (OAS) as Liberal Leader Bob Rae blasts the Prime Minister, telling him "we're not going to put up with it, and neither are the Canadian people." Sadly, far too many Canadians are already getting screwed on pensions and in the near future, they're going to get clobbered on housing.The Chief Actuary seems to inadequately portray the effect of excluding TFSA withdrawals from GIS income test. Indeed, a TFSA account is an asset and assets are not taken into account in any event for GIS income test purposes. Therefore, TFSAs will not increase GIS expenditures.Secondly, RRSP withdrawals are taken into account for GIS income test purposes. This is inconsistent with how TFSAs are treated.
I insist on the fact that the GIS take up rates and amount of benefits are not affected by whether or not:
As a matter of fairness and common sense, only the current year’s investment earnings (while over age 65) on TFSAs and RRSPs, should be taken into account for GIS income test purposes.
- a given taxpayer purchases TFSAs and
- TFSAs are excluded for GIS income test purposes.