Andrew Pyle
January 15, 2022
Why are some savings plans so stingy?
January marks that time of the year when people make resolutions to get in better shape, whether that be mentally, physically or financially. It is a month when new goals are set, and old ones re-evaluated. It is also that time of the year when tax efficiency is top of mind and we look to see if we are taking advantage of all the opportunities that are available. The three main ones are (A) our RRSP, (B) our TFSA and (C) an RESP for our kids or grandkids, if we have set one up. We have spent the last two weeks doing exactly this with clients, but it got me wondering whether we are actually being given all the opportunities we should.
What I mean by this is just how much of our savings are we allowed each year to contribute to these tax deferred (or tax free) vehicles, who decides it and what are the numbers based on. The “who” part of this easy and that is the Canada Revenue Agency, or the federal government to be more specific. At different times of the year, the government will announce the annual contribution limits. For many Canadians, these values seem to appear suddenly. Well, this is obviously true and, at the end of the day, the allowance for any savings to be directed to registered plans is at the discretion of the government. There was a time when RRSPs, RESPs and TFSAs didn’t exist in Canada. Even during their existence, rules have changed and, even when the formula for regular adjustment is made public, even there the situation can change at Ottawa’s pleasing.
The TFSA came into being in 2009 at an initial annual contribution limit of $5000 for each Canadian resident 18 and over, there was an inflation adjustment applied each year. If the adjustment took the contribution past the midway point between the current limit and the next $500 mark, the limit for the next year was revised up to that next mark. Hence, in 2013, it was finally adjusted to $5500. It stayed there for two years but, in 2016, it was bumped to $10,000. Unfortunately, it was dropped right back to $5500 a year later and stayed there until 2019, when it was finally lifted to $6000. And that is where it is for this year too. The point of this discussion, however, is not to look at the changes in rules surrounding registered plans, but to look at the equity between them in relation to macro fundamentals. Let’s start with a simple comparison.
Back in 2007, the federal government did away with annual maximum contributions to RESPs and put in place a lifetime contribution limit per student of $50,000. As mentioned above, the initial TFSA contribution was established at $5,000 in 2009. In that same year, the maximum dollar amount RRSP contribution was $21,000. Now, fast forward to 2022. The lifetime RESP maximum for a student is still $50,000 (a zero percent increase in 13 years), the TFSA limit is $6,000 (a 20% increase from 2009) and the RRSP limit is $29,210 (a 39% increase). That’s a pretty wide range and the only one that comes relatively close to the increase in the cost of living is the RRSP, as consumer prices have risen by about 29% during this period. Personal disposable incomes have increased by more than 54%.
Put another way, the inflation-adjusted (or real) level of contributions to RESPs and TFSAs has gone down since 2009. Of course, using the consumer price index basis of inflation for either of these misses the point. Education costs have increased by way more than the general consumer price basket, with the CPI education component alone rising by 38%. That index measures more than post-secondary school costs, but you get the idea. Someone who could contribute the maximum $50,000 towards a student’s RESP in 2009 would have accumulated enough to probably pay for four years of post-secondary schooling today. The majority of Canadians do not have access to this lump sum though, yet even making regular $2500 contributions each year, and attracting the maximum Canadian Education Savings Grant (CESG) of $500 per year, would have gotten them to maybe three years of schooling by now. The problem is that education costs continue rise beyond the rate of inflation, but the amount that can be put into the RESP hasn’t changed. Furthermore, I would argue that the investment returns from 2009 to 2021 will be hard to replicate from 2022 to 2034, which means there will be a greater emphasis on organic saving to achieve those education goals.
So, how about the TFSA? As much as everyone had hoped that the limit would have been raised to $6500 for 2022, it didn’t happen. Some may be scratching their heads given all the talk of higher inflation, so shouldn’t the limit have been adjusted by now? The problem lies in how Ottawa uses inflation indexation. You see, even though inflation last month was 4.7%, the calculation used for adjusting the TFSA limit is the inflation rate between the average of the CPI basket from October to September in one year to the same period in the next. Based on that, we only saw a 2.4% inflation rate as of September 2021.
Now, if we were to maintain that pace over the next nine months (i.e., 0.2% per month), then the indexation rate for next year will be 3.9%. The problem is that it will still only give us an adjusted TFSA limit of $6,234 – not quite enough to bump it to $6,500.
And this is the key flaw of this method. It takes the current contribution limit as the basis for the calculation instead of where the actual inflation-adjusted values are each year. Put it another way. Ignoring the temporary lift in the TFSA limit to $10,000 back in 2015, had we simply applied the CRA’s October-September average methodology, the limit for the TFSA today would be $6,365. Instead of a 20% increase from 2009, the limit would be 27% higher. That may not sound like much but multiplied across total savings put into TFSAs in Canada, this would be a lot more money protected from tax. Unfortunately, in a world of record deficits and ballooning government debt, tax will likely take a front seat to savings.
The strategy for individuals and families is the same. Try to minimize the aggregate amount of tax over a lifetime by employing all available savings strategies at your disposal. Which ones you ultimately use and to which extent will depend on a careful analysis of current and future income, needs and objectives. A little luck doesn’t hurt either, whether in the form of well-behaved financial markets or well-behaved policies.