At the end of 2022 (the last year for which records are available) 17.7 million Canadians held 28.2 million
Tax Free Savings Accounts (TFSAs). Numbers are not available for where those accounts are held,. However, speaking from my experience in working with average Canadians, more than half of those are likely held by Chartered banks and near banks.
I always ask prospective clients why they had their TFSA in a bank. The usual answer? "It's a savings account and I want to get more interest from my savings!"
Certainly, earning more is a worthwhile objective, but what's the impact on a family's finances from this thinking?
Let's invest $10,000 in a one year GIC inside a TFSA. At the current rate of 3.5%, the GIC will earn $350 interest. Outside the TFSA, this interest is regular income. At the lowest federal tax rate, this extra income would increase taxes due for the year by $73. That is the impact of the TFSA on interest income!
What is the Alternative?
Instead, let's invest the $10,000 in an index fund which returned an average of 9%. At the end of 10 years, the total investment account would be $23,674. As a capital gain, 50% of the increase would be added to annual income. This additional income creates a tax liability of $2,804 at the lowest federal tax rate, or an average of $280 a year. As the returns and the marginal tax rate increase the benefit of the TFSA increases faster!
So why don't Canadians take advantage of TFSAs this way?
Most Canadians have their TFSAs in a bank, because "Banks are where we save!" Could this belief be part of the motivation for the name of the TFSA?
What's in a Name?
In 2008, the Canadian government issues a discussion paper asking for comments on a Tax Free Investment Account. The only change the Canadian Bankers Association lobbied the government to implement was to change the name of the program.
The banks knew that we "save" at a bank, but we can "invest" anywhere. Changing the name from TFIA to TFSA was a huge marketing benefit, but has had significant cost to Canadians who use it to save, rather than to invest!
What Can be Done Now?
The resolution of this misunderstanding of the purpose of TFSAs cannot be implemented by the industry. The TFSA was created by Income Tax law changes. The name can only be changed as part of an update to that law. We need to put pressure on our Members of Parliament to restore the original name. The companies who benefit most from the existing name have a powerful lobby in Ottawa!
How profitable are TFSAs invested in GICs for the bank? Check out our post on
How the Banks Make Money. $10,000 invested in a 5 year GIC currently offered at 3.3% costs the bank $330 a year. Lent out in a 5 year mortgage, the GIC backs a $200,000 mortgage. 5 year mortgages are currently offered at 5.09%. So the bank makes 10,180 every year on your money.
That's right. The bank is earning more than 100% on your money! We recognize that fixing this problem for average Canadians could well have significant impact on the Canadian banking system. It's still the right thing to do for average Canadians! Talk to your federal politician!
For other examples of changes we recommend to help Canadian investors check out our
Industry Issues blog posts.
