The Conservative government is facing calls to change the rules around tax-free savings accounts now before a loophole means some of Canada's wealthiest people could start receiving "welfare for seniors."
TFSAs were created in 2009 and designed to encourage Canadians to save by – as the name suggests – putting such accounts out of the reach of the Canada Revenue Agency when it comes to taxing capital gains and other income such as dividends.
However, because the accounts operate outside the tax system, they are also ignored when it comes to income-tested government benefits such as Old Age Security (OAS), the Guaranteed Income Supplement (GIS), and even the allowance designed with the country's lowest income seniors in mind.
"The question is: what do we do?" asks Rhys Kesselman, who holds the Canada Research Chair in Public Finance at Simon Fraser University. "Do we continue to pay the GIS, which is intended for low-income seniors, to people who have large amounts in their TFSA?"
Kesselman estimates a person who starts squirrelling away significant amounts into their TFSA at an early age and invests it in a diversified portfolio can expect to have $750,000 to $1 million or more in that account by the time they reach retirement age – a sort of personal endowment fund that would continue to generate income tax free.
"If you're balanced between fixed income and equities, [you could get] six per cent, $60,000 a year — and that's tax-free," he said.
Taxable income includes any money received from pension funds — be it from the Canada Pension Plan, an employer's plan or a registered retirement savings plan.
Although some wealthier Canadians may find themselves with the enviable situation of drawing too much money from these sources, it is possible to suppress this income and thereby qualify for government assistance.
CPP allows for deferment until the age of 70 and RRSPs can be left untouched until the contributor turns 71, and the payoff for those who do so can be worth tens of thousands of dollars in government money.
"People are going to do it, not a lot of people, but people are absolutely going to [intentionally keep their income low]," says Finn Poschmann of the C.D. Howe Institute.
Under current rules, couples in their 60s who keep their taxable income — which excludes TFSA money — below $32,000 a year, could be entitled to nearly $30,000 in government benefits including the allowance, a payment meant only for low-income couples.
"There will be a fairness perception problem," according to Poschmann.
'It's kind of negligent of governments to make a broad-sweeping, unrestrained promise that is bound not to be fulfilled.' - Rhys Kesselman, Canada Research Chair in Public Finance at Simon Fraser University
"I think just in terms of what taxpayers, voters think the GIS is for — they won't be too happy to see people with hundreds of thousands, or even a million or two million in a TFSA conceivably drawing the GIS," adds Kesselman.
Beyond the sense of fairness, there is also a looming fiscal cost.
In a recently released report, Canada's chief actuary estimates the OAS and GIS loophole will add about $4 billion to the government's annual net costs under the programs by 2050.
But those calculations were based on the current annual contribution limit of $5,500 – not the $10,000 limit expected to be announced in the 2015 budget to fulfil the last of the Conservative government's major election promises from the 2011 campaign.
A change of that nature will almost certainly amplify the projected cost to the treasury.
Both Poschmann and Kesselman believe changes to the rules are inevitable because of these factors.
"When it hits the fan in a big way, the public is going to react negatively and governments, I think, will respond," says Kesselman.
Poschmann cautions against scrapping TFSAs, pointing out what may seem an unfair loophole for the wealthy is one of the scheme's greatest assets for the poor: the fact it doesn't affect income-tested eligibility for other benefits.
"Part of the problem in our former system was the presence of income tests," Poschman explains, "it made it really dumb for low-income seniors to save in RRSPs because you have futile savings, you got dinged."
Income vs. asset tests
He suggests asset tests, rather than income tests, could be a means of addressing the issue.
The trick is to find a way of objectively cutting off or curtailing income benefits for the wealthy, while not punishing middle- or low-income earners who happen to be diligent savers.
Although the problem seems to be more than 30 years down the road, Kesselman urges the government to make changes quickly so the public knows what the rules will be from the outset.
"It's kind of negligent of governments to make a broad-sweeping, unrestrained promise that is bound not to be fulfilled," he says.